BMO – Tax Court of Canada finds that former s. 39(2) extended to (and carved out) FX gains on s. 39(1) dispositions

BMO used a tower structure for a U.S.$1.4 billion financing of its U.S. subsidiaries in which a subsidiary Nevada LP of BMO applied third-party borrowings made by it (or by BMO and contributed to the LP) to subscribe for common shares of an NSULC subsidiary, which acquired shares in an LLC, which lent the U.S.$1.4 billion to the U.S. subsidiaries. When the tower was unwound approximately five years later, the CRA position would have been that the FX loss realized by the LP on winding up the NSULC would have been reduced under the s. 112(3.1) stop-loss rule by the dividends paid during the five years on the NSULC shares - so that such loss would only partially offset the FX gain realized by BMO (directly and “through” the LP) on repayment of the U.S.$1.4 billion third-party borrowing. However, BMO had forestalled this result by instead having the NSULC pay its dividends as preferred share stock dividends. CRA accepted that this worked technically, but applied the general anti-avoidance rule on the basis that it was an abusive avoidance of s. 112(3.1).

Graham J found that there was no “tax benefit,” so that GAAR did not apply, because the loss of the LP on the disposition of the NSULC shares was not a loss from the “disposition of a share” as required by s 112(3.1) and instead was deemed by s. 39(2) to be a loss from the “disposition of currency.” Thus, he found that the pre-August 2011 version of s. 39(2) extended to dispositions of capital property, rather than being restricted to the settlement of foreign-currency obligations. Points made by Graham J included:

• Unlike s. 39(3), s. 39(2) stated that it applied “notwithstanding” s. 39(1), which was explained by s. 39(2), unlike s. 39(3), extending to dispositions (s. 39(1) turf) rather than only to obligation settlements.
• S. 39(2) went on to deem the capital gains and losses thereunder to be from the disposition of foreign currency – which presumably was motivated by a concern that they otherwise would be considered to have the character of any property that was actually disposed of.

Neal Armstrong. Summary of The Bank of Montreal v. The Queen, 2018 TCC 187 under s. 39(2).