7 January 1991 Income Tax Severed Letter - Foreign Accrual Property Income

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.

Dear Sirs:

Re: Foreign Accrual Property Income (“FAPI”)

This is in response to your correspondence dated October 29, 1990. You have requested the Department's view whether it is appropriate to use generally accepted accounting principles (“GAAP”) in calculating the FAPI income of a foreign affiliate resident in a country that is subject to hyper-inflation. Your letter presented the following set of hypothetical facts to illustrate your question:

• 1. The foreign affiliate earns 10,000,000 foreign currency units (“FCU”) of interest income during the year. The income is earned and received by the affiliate consistently over the course of the year.
2. The relevant foreign exchange rates are:
• • at the commencement of the year Cdn:$1.00 - 1 FCU
• • average over the course of the year Cdn:$1.00 - 10 FCU
• • at the end of the year Cdn:$1.00 - 100 FCU

In your view the FAPI of the foreign affiliate calculated in accordance with section 1650 of the CICA Handbook would be Cdn $100,000 (i.e. the 10,000,000 FCU of interest income converted at the average exchange rate for the year less the accrued foreign exchange loss at the end of the year of Cdn $900,000 on the 10,000,000 FCU placed on deposit by the foreign affiliate to earn additional interest income). You question whether this amount would be the FAPI of the affiliate for the purposes of paragraph 95(1)(b) of theIncome Tax Act(the “Act”).

It is the position of the Department that unless there is a specific provision of the Act which dictates otherwise, income for the purposes of subsection 9(1) (and therefore paragraph 95(1)(b)) of the Act should be determined in the same manner as it is for financial statement purposes, assuming the method used for financial statement purposes is in accordance with GAAP. The comments set out in IT-95R indicate that this holds true for translation of foreign currency transactions on income account. However, in respect to foreign exchanges gains or losses on capital account (e.g. the funds on deposit), pursuant to subsection 39(2) of the Act, the taxpayer has made a gain or sustained a loss in a foreign currency only where there has been a transaction resulting in a gain or loss.

In your example, the foreign currency funds on deposit would not be considered disposed of until they are converted into another currency or are used to purchase a negotiable instrument or some other asset. Accordingly, the foreign exchange loss accrued on the funds on deposit would be on account of capital and would not be recognized during the year for the purposes of the Act. Therefore, the FAPI of the foreign affiliate for the year would be Cdn $1,000,000 (i.e. 10,000,000 FCU converted at the average rate of exchange for the year).

We hope the above will be of assistance to you.