26 November 1998 External T.I. 9818605 - FOREIGN EXCHANGE LOSS

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: Application of loss denial rules to a foreign exchange loss realized on the payment of a loan owing to an affiliated person

Position: Loss denial rules do not apply

Reasons: Loss arises by virtue of the payment of the loan and not by virtue of the disposition of property to the creditor to which the loss denial rules apply

XXXXXXXXXX 		981860
D. Boychuk
Attention:  XXXXXXXXXX 

November 26, 1998

Dear Sirs:

Re: Foreign Exchange Loss on Non-Arm’s Length Debt

We are writing in response to your letter of July 14, 1998 wherein you requested our views on the application of the loss denial rules in paragraph 40(2)(g) and subsections 40(3.3) and (3.4) of the Income Tax Act (Canada) to a foreign exchange loss realized on the repayment of a loan.

You have asked us to assume that the loan was made to a “taxable Canadian corporation” (“Canco”) by its “controlled foreign affiliate” (“CFA”). The loan is denominated in and repayable in a foreign currency and bears interest at a commercial rate. Since the time the loan was originally made, the foreign currency has appreciated against the Canadian dollar such that, at the time Canco repays the loan, it realizes a foreign exchange loss which is deemed to be a capital loss pursuant to subsection 39(2). Canco and CFA are “affiliated persons” within the meaning of section 251.1.

Issue

The issue is whether the deductibility of the capital loss realized pursuant to subsection 39(2) would be denied under either paragraph 40(2)(g) or by virtue of subsections 40(3.3) and (3.4).

Our Comments

In your letter, you have outlined what may be an actual fact situation related to transactions and events which have taken place. The review of such situations is generally the responsibility of the local taxation services offices and, as outlined in paragraph 22 of Information Circular 70-6R3, it is not our practice to provide specific opinions on factual situations otherwise than in the context of an advance income tax ruling. In any event, a request for an advance income tax ruling cannot be considered where the transactions are completed or where the issues involved are primarily questions of fact. Nevertheless, we are prepared to provide the following comments which we hope will be of assistance.

Subsection 39(2) provides for the tax treatment of foreign exchange gains and losses which result from the fluctuation after 1971 in the value of currency or currencies of one or more countries other than Canada relative to Canadian currency.

Paragraph 40(2)(g) applies to deem a taxpayer’s loss, if any, from the disposition of a property that is, among other things, a “superficial loss,” to be nil. In general terms, a superficial loss is a loss from the disposition of a particular property where during the period beginning 30 days before and ending 30 days after the disposition, the taxpayer or a person affiliated with the taxpayer acquires property that is, or is identical to the particular property. A superficial loss does not include a loss from a disposition to which subsection 40(3.4) applies.

Subsections 40(3.3) and (3.4) operate to defer the recognition of losses on certain dispositions of non-depreciable capital property. Where the conditions set out in subsection 40(3.3) are satisfied, subsection 40(3.4) deems the transferor’s loss, if any, from the disposition to be nil until the earliest of the events described in that provision occur. Subsection 40(3.3) provides that subsection 40(3.4) applies when:

(a) a corporation, trust or partnership disposes of a particular capital property;

(b) during the period that begins 30 days before and ends 30 days after the disposition, the transferor or a person affiliated with the transferor acquires a property that is, or is identical to, the particular property; and

(c) at the end of the period, the transferor or a person affiliated with the transferor owns the property.

In our view, paragraph 40(2)(g) and subsections 40(3.3) and 40(3.4) do not apply to a capital loss realized by a debtor on the payment of a loan since the loss does not arise from the disposition of a particular property by the debtor that is, or is identical to, property acquired by the creditor. The loan is a liability of the debtor and, as such, is not property of the debtor. Consequently, the repayment of the loan does not, in itself, result in a disposition of property by the debtor. In addition, although subsection 39(2) deems the loss realized on the payment of the loan to be a capital loss from the disposition of “a currency of a country other than Canada,” this provision does not deem the creditor to acquire the foreign currency deemed to be disposed under this provision.

We trust that our comments will be of assistance.

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with paragraph 22 of Information Circular 70-6R3.

Yours truly,

for Director
Reorganizations and International Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch