7 October 2016 APFF Roundtable Q. 17, 2016-0652781C6 F - Functional currency and acquisition of control -- translation

Principal Issues: 1. Does the CRA consider that a deferred gain resulting from the application of subsection 261(10) can be realized in the year ending immediately before an acquisition of control if an election pursuant to paragraph 111(4)(e) is made with respect to a pre-transition debt? 2. If so, do subsections 40(10)/(11) apply with respect to the pre-transition debt such that the same gain is not realized again when the debt is repaid?

Position: 1. No. 2. No.

Reasons: 1. Subsection 111(12), and therefore subsection 111(4), has no application with respect to the portion of the foreign exchange gain or loss on a pre-transition debt that is governed by subsection 261(10). 2. Subsections 40(10)/(11) don't apply to that portion given that subsection 111(12) does not apply.

October 7, 2016 APFF Federal Roundtable- 2016 Conference

Question 17 - Choice of Functional Currency and Acquisition of Control

In the context of the acquisition of control rules, subsection 111(12) provides that, if at any time a taxpayer owes a foreign currency debt in respect of which the taxpayer would have had, if the foreign currency debt had been repaid at that time, a capital loss or gain, the taxpayer is deemed to hold property for the purposes of subsection 111(4). Accordingly, the taxpayer may make an election under paragraph 111(4)(e) to realize an exchange gain before the time of acquisition of control.

On the other hand, if the foreign exchange gain is a gain arising from a pre-transition debt as calculated in subsection 261(10) of a taxpayer who has made a functional currency election, it appears that the election under paragraph 111(4)(e) ITA would have no effect on the foreign exchange gain that would otherwise be realized pursuant to subsection 261(10).

Questions to the CRA

(a) Can the CRA indicate whether it considers that a gain arising from the application of subsection 261(10) can be realized in the year terminating immediately before an acquisition of control, if a paragraph 111(4)(e) election is made respecting a pre-transition debt?

(b) If such an election is made, do subsections 40(10) and (11) apply respecting the foreign exchange gain on the pre-transition debt such that an equivalent gain is not realized again at the time that such debt is repaid?

CRA response to Q.17(a)

Unless otherwise stated, phrases in quotes refer to terms as defined in subsection 261(1) of the Act.

The CRA is of the view that the provisions of subsection 111(4) of the Act, including the election under paragraph 111(4)(e), cannot be applied in respect of the portion of the foreign exchange gain or loss realizable by virtue of subsection 261(10) with respect to a "pre-transition debt" of a taxpayer, for the following reasons.

Paragraph 111(4)(e) depends on the application of subsection 111(12) which, in turn, requires the presence of a "foreign currency debt". The CRA is of the view that this determination is made at the time immediately before the acquisition of control. Subsection 111(8) defines "foreign currency debt" as a debt denominated in the currency of a foreign country. For an elected functional currency taxpayer, subparagraph 261(5)(f)(ii) provides that the term "currency of a country other than Canada" in this definition is replaced, in respect of the taxpayer and the particular taxation year, with the expression "currency other than the taxpayer's elected functional currency."

Where a "pre-transition debt" is denominated in the same currency as the "functional currency" of the taxpayer, it could not qualify as "foreign currency debt" for purposes of subsection 111(12) where the acquisition of control occurs in a "functional currency year" of the taxpayer. Thus, the provisions of subsection 111(4) would not apply.

With respect to a "pre-transition debt" denominated in a currency other than the "elected functional currency" of the taxpayer, it could qualify as a "foreign currency debt" for purposes of subsection 111(12). However, such a debt would be deemed, by virtue of subsection 261(9), to have been issued immediately before the taxpayer’s first "functional currency year" for the purposes of determining the amount of the taxpayer’s gain or loss, for a functional currency year of the taxpayer (other than gain or loss arising under subsection 261(10)), that is attributable to a fluctuation in the value of a currency. Thus, although the "pre-transition debt" is a "foreign currency debt" for purposes of subsection 111(12), only the fluctuation of the value of that currency vis-à-vis the "functional currency" from the time specified in subsection 261(9) until immediately before the acquisition of control would be subject to subsections 111(4) and (12).

CRA response to Q.17(b)

As such an election cannot be made in respect of the portion of the foreign exchange gain realizable by virtue of subsection 261(10), subsections 40(10) and (11) will not apply.

Sophie Larochelle
Dave Beaulne
October 7, 2016
2016-065278