25 November 2024 External T.I. 2023-0974111E5 - Elected Functional Currency and Expenditure Limit

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.

Principal Issues: For the purpose of computing the expenditure limit under subsection 127(10.2) of a taxpayer who reports in its elected functional currency, which exchange rate should be used to convert the amount of taxable capital employed in Canada (TCEC) of an associated corporation into the taxpayer’s elected functional currency?

Position: The taxpayer should use the spot rate for the last day of the taxation year of the associated corporation for which the TCEC is computed to convert it into the taxpayer’s elected functional currency.

Reasons: For the purpose of computing the expenditure limit under subsection 127(10.2), the day the TCEC of the associated corporation is considered to “arise” for the purposes of paragraph 261(5)(c) is the last day of the taxation year of the associated corporation for which it is computed.

									November 25, 2024

	XXXXXXXXXX							HEADQUARTERS
 							 		Income Tax Rulings
      								Directorate
      								Ina Eroff

								 	2023-097411

Elected Functional Currency and Expenditure Limit

This letter is in reply to your request sent to us on July 13, 2023 for interpretive assistance regarding the application of the functional currency rules under section 261 in the context of computing the expenditure limit under subsection 127(10.2) of a taxpayer (the “Taxpayer”) who is a Canadian-controlled-private corporation (“CCPC”) that reports its Canadian tax results in its elected functional currency.

Unless otherwise stated, every statutory reference herein is a reference to the relevant provision of the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended, (the “Act”) and all terms used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated. All references to dollar amounts are to Canadian dollars, unless stated otherwise.

Interpretative issue:

The Taxpayer may reduce its Part I tax by the amount of an “investment tax credit” (footnote 1) (“ITC”) granted in respect of scientific research and experimental development (“SR&ED”) “qualified expenditures” (footnote 2) . Generally speaking, the ITC is 15% of the taxpayer’s “SR&ED qualified expenditure pool” (footnote 3) . The Taxpayer, being a CCPC, may also be eligible to claim an additional ITC up to 20% (footnote 4) of its SR&ED qualified expenditure pool, subject to its “expenditure limit” for the year (footnote 5) .

The “expenditure limit” (and consequently the additional 20% ITC) is gradually reduced when the total of all taxable capital employed in Canada (footnote 6) (“TCEC”) of the Taxpayer and its associated corporations exceeds $10 million. (footnote 7) Associated CCPCs of the Taxpayer, if any, must file Schedule 49 to allocate the “expenditure limit” for a calendar year among them. (footnote 8)

In accordance with paragraph 261(5)(a), the Taxpayer’s Canadian tax results are to be determined using its elected functional currency. When an associated corporation of the Taxpayer reports its Canadian tax results in Canadian dollars, the associated corporation’s TCEC used to determine whether the “expenditure limit” of the Taxpayer is reduced needs to be converted into the Taxpayer’s elected functional currency. The question is what exchange rate should be used in this case.

One approach would be to view the TCEC of the associated corporation as the particular amount that is relevant in computing the Taxpayer’s Canadian tax results and that is to be converted into the Taxpayer’s elected functional currency using the spot rate on the date when the TCEC arose. Alternatively, each component of the TCEC calculation can be converted separately, potentially leading to a different amount of TCEC expressed in the Taxpayer’s elected functional currency as different relevant spot rates could apply in making that conversion.

Under section 181.2, the computation of the TCEC of a corporation for a taxation year requires determination of multiple components. That includes the amount of its capital stock, retained earnings, contributed surplus and any other surpluses at the end of the year. That also includes the amount of its reserves for the year, of all loans and advances to it at the end of the year and of its various indebtedness at the end of the year. The list also includes the amount of dividends declared but not paid by the corporation before the end of the year as well as the carrying value at the end of the year of certain listed assets of the corporation.

Pursuant to paragraph 261(5)(c), if a particular amount that is relevant in computing the Taxpayer’s Canadian tax results for the particular taxation year is expressed in a currency other than the Taxpayer’s elected functional currency, the particular amount is to be converted to an amount expressed in the Taxpayer’s elected functional currency using the relevant spot rate (footnote 9) for the day on which the particular amount arose. One might read paragraph 261(5)(c) as referring to the aggregate amount of the TCEC of the associated corporation or to each component of the TCEC separately.

In addition, one might read subsection 261(7) as requiring that any amount of each component of the TCEC of the associated corporation that existed in the last Canadian currency year of the Taxpayer should be converted into the Taxpayer’s elected functional currency under paragraphs 261(7)(a) and (h) instead, where applicable. Subsection 261(7) sets out various transitional rules for converting tax attributes from Canadian currency to a taxpayer’s elected functional currency using the relevant spot rate for the last day of the taxpayer’s last Canadian currency year. This provision generally applies to amounts that were determined in or in respect of a taxation year preceding the taxpayer’s first functional currency year but that are relevant in determining the taxpayer’s Canadian tax results for the particular functional currency year.

Our response:

The amount relevant in computing the Taxpayer’s Canadian tax results within the meaning of section 261 is the amount of the TCEC of the associated corporation computed in Canadian dollars, because that is the amount included in the formula computing the expenditure limit of the Taxpayer under subsection 127(10.2). The day the TCEC of the associated corporation is considered to “arise” for the purposes of determining the conversion rate according to paragraph 261(5)(c) is the last day of the taxation year of the associated corporation for which it is computed because that is the day when the amount of the TCEC is determined pursuant to section 181.2 (hence when an amount relevant to computing the Taxpayer’s Canadian tax results is created). (footnote 10)

Since the purpose of the expenditure limit as used in subsection 127(10.1) is to limit the availability of the additional ITC based on the size of the business determined by reference to TCEC of all associated corporations, amounts that comprise TCEC of the associated corporations should be converted into the functional currency of the Taxpayer using the spot rate on the day when the relevant TCEC is computed in order to estimate their current value to the business. Applying paragraph 261(5)(c) to each component of the TCEC of each associated corporation separately would be administratively burdensome, especially when the associated corporations could not rely on subsection 261(7). Since the expenditure limit has to be shared among associated CCPCs pursuant to subsection 127(10.3), the suggestion that certain components of the TCEC of the associated corporations should be converted under subsection 261(7) would create a dilemma for corporate groups with multiple functional currency reporters with different last Canadian currency years.

If prior to the date of this letter the Taxpayer was consistently using a different method for converting the TCEC of its associated corporation in its elected functional currency and claimed additional ITC which would not have been available if the Taxpayer used the conversion method put forward in this letter, the CRA will not challenge the computation for those periods.

Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.

Yours truly,

Charles Taylor
Section Manager
For Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Defined in subsection 127(9).

2 Defined in subsection 127(9).

3 Paragraph (a.1) of the definition “investment tax credit” in subsection 127(9). “SR&ED qualified expenditure pool” is also defined in subsection 127(9).

4 Paragraph (e) of the definition “investment tax credit” in subsection 127(9); subsection 127(10.1).

5 Determined in accordance with subsection 127(10.2).

6 Computed in accordance with section 181.2 or 181.3.

7 TCEC of each associated corporation is computed for its last taxation year that ended in the last calendar year that ended before the end of the particular taxation year for which the expenditure limit of the Taxpayer is calculated.

8 Subsection 127(10.3).

9 Defined in subsection 261(1).

10 To compute the Canadian tax results for a particular taxation year of the Taxpayer, the TCEC of the associated corporation that is relevant is the TCEC for the last taxation year that ended in the last calendar year that ended before the end of the particular taxation year for which the expenditure limit is calculated.