Foreign Exchange


Funding of trading operations or money-lending business

Foreign exchange gains or losses made or sustained by a taxpayer in the course of its trading operations, including foreign exchange gains or losses arising on intercompany accounts that were incurred in order to purchase inventory, generally will be made or sustained on income account (Eli Lilly, Tip Top Tailors, Aluminium Union, Northern Sales, International Nickel). This will be so even if there is a delay of many years between the time that the foreign currency debt was so incurred and the time that the foreign exchange gain or loss was realized on payment or settlement of that debt (DWS, Aluminium Union). This also will be the case even if the foreign currency borrowing to fund trading activities is secured by a refinancing of a capital asset (see Netupsky).

Although consistently with the above principles, a foreign exchange gain or loss on a borrowing of funds to be used in a money-lending business should be on income account (see Avco), foreign currency borrowings by a leasing company in order to finance the acquisition of capital assets (such as aircraft) to be leased by it will give rise to foreign exchange gains or losses on capital account - even though in a broad sense such a company is in a financing business (CCLI). Foreign currency borrowings of a money-lender that provide permanent capital rather than funds to be lent in the ordinary course of that business may give rise to foreign exchange gains or losses that are on capital account (see Commercial and General Acceptance).

Investment transactions

Conversely, a foreign exchange gain or loss arising on a borrowing incurred in order to fund a capital acquisition will be on capital account (Neonex, Alberta Gas), as will generally also be the case where the borrowing was incurred by the borrower in order to provide it with semi-permanent working capital (Shell, see also Woolworth, Energy Resources), or to provide it with "fixed capital" (see Davies v. Shell).

Ethicon Sutures accepted the principle that if a foreign exchange "gain arises out of the investment of idle funds or the appreciation of a temporary investment, the gain will be treated as a capital gain." Ethicon Sutures also apparently accepted that if U.S. dollar notes had been purchased by the taxpayer exclusively in order to fund the payment of dividends, foreign exchange gains arising on those note would have been capital gains. However, as the notes also could be used to purchase inventory, the gains instead were on income account.

Hedging transactions

Whether a foreign exchange gain or loss arising from a hedging contract is on income or capital account depends on the characterization of the debt obligation (or asset) to which the hedge relates (Shell). A foreign exchange contract such as a forward sale contract will not be found to be a hedge of a capital asset, such as an investment in a foreign subsidiary, if the amount of the contract is not established to bear a close relationship to the value of the investment (Salada).


Shell Canada Ltd. v. Canada, 99 DTC 5669, [1999] 3 S.C.R. 622, [1999] 4 CTC 313

FX hedging gain was capital gain as hedged borrowing was on capital account

The taxpayer effectively converted a NZ$150 million borrowing into U.S. dollars by entering into a forward contract for the exchange of New Zealand dollars for U.S. dollars with a Japanese bank. It realized a foreign exchange gain of U.S.$19 million on the maturity of the debenture (based on changes in the spot N.Z./U.S. exchange rate) and a further gain of U.S.$2 million on the forward exchange contract resulting from the exchange thereunder of U.S.$79 million for NZ dollars worth U.S.$81 million (or, under another possibly acceptable method of viewing the contract, as the result of acquiring N.Z. dollars at a cost that was U.S.$2 million less than the amount for which they were immediately disposed of in order to discharge the borrowing).

McLachlin J. found that the U.S.$19 million gain was realized on capital account given that the purpose of the borrowing was to provide the taxpayer with working capital for a five-year term. In finding that the U.S.$2 million gain was also on capital account, she noted (at para. 70) that:

"Whether a foreign exchange gain arising from a hedging contract should be characterized as being on income or capital account depends on the characterization of the debt obligation to which the hedge relates."

Locations of other summaries Wordcount
Tax Topics - General Concepts - Substance legal relationships prevail over economic realities 201
Tax Topics - General Concepts - Tax Avoidance taxpayers entitled to rely on structure of their transactions 170
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) borrowing in legal substance was in weak currency 174
Tax Topics - Income Tax Act - Section 67 s. 67 does not apply where provisions, having their own internal limiting clauses, apply 96
Tax Topics - Statutory Interpretation - Specific v. General Provisions general reasonableness provision should not be applied to interest which has its specific s. 20(1)(c) reasonableness limitation 96

Ethicon Sutures Ltd. v. The Queen, 85 DTC 5290, [1985] 2 CTC 6 (FCTD)

Foreign exchange gains realized by the taxpayer as a result of the purchase of U.S. dollar term deposits were income rather than capital gains. Although Cullen, J. accepted that the funds invested by the taxpayer would have been of a capital nature if they had been exclusively dedicated to the payment of dividends to the taxpayer's U.S. parent, he found that there was a secondary intention to have the funds so invested available from time to time to pay for purchases of inventory.

Neonex International Ltd. v. The Queen, 78 DTC 6339, [1978] CTC 485 (FCA)

borrowing to fund proposed acquisition (through Buyco) on capital account

The taxpayer company borrowed in U.S. dollars from a New York bank in order to help finance a proposed acquisition of a control interest in another Canadian company ("Maple Leaf"). This was to be accomplished by the taxpayer lending the borrowed funds on an interest-bearing basis to a Canadian subsidiary ("Overwaitea"), with Overwaitea funding the acquisition with its own funds but being put back into funds through receipt of the proceeds of the loan from the taxpayer. In fact, the acquisition of Maple Leaf did not proceed.

The taxpayer was found to have incurred its loan, not as part of a business of lending money to its subsidiaries, but in order to finance the acquisition of the Maple Leaf shares, which would have been a capital transaction. The interposition of Overwaitea did not change the character of the transaction. An exchange gain realized upon repaying the U.S. dollar loan accordingly was a capital gain.

Salada Foods Ltd. v. The Queen, 74 DTC 6171, [1974] CTC 201 (FCTD)

forward did not closely relate to capital investment

A gain realized by the taxpayer on closing out a forward sale contract under which it agreed to purchase pounds sterling at a specified rate of exchange, was taxable. Although the taxpayer alleged that it entered into the contract to hedge its investments in U.K. subsidiaries, the amount of the contract was not established to bear a close relationship to the value of its investment. "In arranging the forward sale contract the Plaintiff acted in exactly the same fashion as a dealer or speculator in securities would act."

Northern Sales (1963) Ltd. v. MNR, 73 DTC 5200, [1973] CTC 239 (FCTD)

incurred in trading operation

A grain trading company, which borrowed U.S. dollars from an American affiliate in order to finance its trading operations, incurred foreign exchange losses on income account.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 96 144

Alberta Gas Trunk Line Co. Ltd. v. Minister of National Revenue, [1972] S.C.R. 498, 71 DTC 5403, [1971] CTC 723

The taxpayer borrowed U.S. $67,000,000 for the construction of capital assets and in the year of borrowing sought to deduct $358,828 from its income, being the difference between $67,000,000 and the equivalent in Canadian dollars at the time of borrowing of U.S. $67,000,000. The supposed loss of $358,828 was not deductible because whether or not any loss would be sustained by the taxpayer would depend upon the exchange rate at the time of the repayment of the loan, and because any such loss would be a capital loss.

Alberta Natural Gas Company v. Minister of National Revenue, 71 DTC 5400, [1971] CTC 718, [1972] S.C.R. 490

Under an amended transportation contract with its shippers, a gas transmission company became entitled, at its option in the event that its construction of the pipe line was financed through U.S. dollar borrowings (as in fact occurred), to have 2/3 of the number of dollars which it charged the shippers in its monthly invoices paid in U.S. dollars rather than Canadian dollars. The U.S. dollars so received by the company were used by it to pay principal and interest on its U.S. dollar borrowings.

Martland, J. was unable to construe the transportation contract in the manner contended by the taxpayer, namely, as providing for payment for the company's services in Canadian dollars coupled with a forward exchange contract for the purchase by the Company from the shippers of U.S. dollars. (The company further contended that under GAAP the U.S. dollars should be valued at their cost to the company.) The full value of the U.S. dollars received by the company formed part of its income.

D.W.S. Corp. v. MNR, 68 DTC 5045, [1968] CTC 65 (Ex Ct), briefly aff'd 69 DTC 5203 (SCC)

The taxpayer, which had been following the practice of recognizing foreign exchange gains or losses on its U.S. dollar trade payables when those payables were repaid rather than recognizing accrued foreign exchange gains or losses, realized a foreign exchange loss when it repaid a debt owing to its U.S. parent for previous purchases of inventories, supplies and other items of a current nature.

The loss was deductible because the related debt had been incurred in trading transactions. The fact that a large portion of the liability had been outstanding for more than 10 years did not transmute it into a capital obligation. The loss was not incurred simply because the taxpayer decided to repay the debt; the loss instead arose from a foreign exchange fluctuation on an obligation that had been incurred in the course of trading.

Aluminium Union Ltd. v. MNR, 60 DTC 1138, [1960] CTC 206, briefly aff'd 63 DTC 1254

The Japanese branch of the taxpayer, whose business consisted primarily of placing the production of associated companies in the export market through branch offices, incurred overdrafts on its yen bank account in Japan in paying duties for imported goods, general administration salaries, travelling expenses and office furnishings. The yen depreciated considerably between 1942, when the Japanese branch was closed due to the outbreak of hostilities, and 1952 when the 1942 amount of the yen overdraft in 1942 was repaid.

The gain was taxable. "Though the buying and selling or the exchanging dollars for yen was not the primary business of the appellant, that operation was necessary for the purpose of its transactions on revenue account and the settlement of its debt with the bank in Japan was a part of its trading operations."

Tip Top Tailors Limited v. The Minister of National Revenue, 57 DTC 1232, [1957] CTC 309, [1957] S.C.R. 703

In 1947 the taxpayer, which anticipated the devaluation of the pound, arranged a line of credit with the London branch of a Canadian bank and arranged for the bank to pay its U.S. suppliers of cloth. When the pound was devalued in September 1949, the taxpayer promptly paid off the overdraft at a gain. Because the overdraft arose in the course of the taxpayer's business rather than as a separate financing transaction, the gain was realized on income account.

British Columbia Electric Railway Co. v. Farrer, 55 DTC 1139, [1955] CTC 198, [1955] S.C.R. 757

The taxpayer purchased inventory goods from its U.S. parent over the period 1939 to 1945 on credit, and deducted the Canadian-dollar equivalent of the U.S. dollar purchase prices as the goods were sold. In 1946, when the Canadian dollar had appreciated relative to the U.S. dollar, the U.S.-dollar indebtedness was paid through the issuance of common shares by the taxpayer.

The foreign exchange gain was fully taxable. "[T]he cost of exchange arising out of fluctuations in foreign currency is an ordinary expense in relation to foreign trade."

See Also

Loblaw Financial Holdings Inc. v. The Queen, 2018 TCC 182, rev'd on s. 95(1) - investment business - (a) (arm's length conduct) grounds 2020 FCA 79, in turn aff'd 2021 SCC 51

short-term debt securities were inventory because they were the raw material for generating swap income

The taxpayer was found to have realized foreign accrual property income from the investing activities of its Barbados subsidiary (GBL). These activities included using funds received from the taxpayer to invest in U.S.-dollar short-term debt obligations and to enter into cross-currency swaps and interest rate swaps with U.S. banks to convert the resulting interest income into fixed-rate Canadian dollar interest revenue. In finding that its resulting foreign exchange gains and losses were realized under s. 95(2)(f) on income account, C Miller J stated (para. 276):

The acquisition of the short term securities, taking their yield and funding a derivatives program to produce a greater yield is … using these short term securities in a manner akin to inventory in an income producing scheme.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 165 - Subsection 165(1.11) requirement met where Crown knew the nature and quantum of the dispute 269
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Foreign Bank CFA qualified as a foreign bank since it was licensed under Barbados law as an international bank 123
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Investment Business - Paragraph (a) Barbados-licensed international bank, which used Loblaw funding to invest responsively to Loblaw considerations, conducted an offside non-arm’s length business 429
Tax Topics - Income Tax Act - Section 95 - Subsection 95(1) - Investment Business - Paragraph (c) employee equivalents was reduced by employee time described in s. 95(2)(b) 290
Tax Topics - Income Tax Act - Section 152 - Subsection 152(4.01) - Paragraph 152(4.01)(a) - Subparagraph 152(4.01)(a)(ii) GAAR is generally a separate matter rather than being subsumed in the allegedly-misused substantive provision 208
Tax Topics - Income Tax Act - Section 245 - Subsection 245(3) application of GAAR required the occurrence of an avoidance transaction (or series) in non-statute-barred years and the relevant previous year’s avoidance transaction did not occur as part of the series 512
Tax Topics - Income Tax Act - Section 248 - Subsection 248(10) hiring of employees 15-years previously to engage foreign bank exception to investment business definition was not part of same series as renewal of foreign bank licence 228
Tax Topics - Income Tax Act - Section 245 - Subsection 245(4) use of Barbados sub to engage in proprietary trading for Canadian parent misused the foreign bank exemption, whose purpose was promoting international competitiveness 336
Tax Topics - Income Tax Act - Section 95 - Subsection 95(2) - Paragraph 95(2)(l) purpose of s. 95(2)(l) exception was to permit non-resident subsidiaries of Canadian banks and dealers to compete internationally 190

George Weston Limited v. The Queen, 2015 TCC 42

cross-currency swap was a hedge notwithstanding no intention to sell underlying indirect U.S. asset

As a result of its financing of the acquisition in 2001 of a U.S. bakery business ("Bestfoods") by indirect subsidiaries through a large issuance by it of (mostly) Canadian-dollar debt, the consolidated debt-to-equity ratio of the taxpayer ("GWL"), which was a Canadian public company, increased well above its internal guidelines of 1:1, and resulted in a credit watch warning from S&P. In order to hedge against the effect that a relative depreciation in the U.S. dollar could have on its creditworthiness and share price, GWL entered into long-term (10 to 15 year) cross currency swaps "fairly close" (para. 71) to the acquisition time (likely within one month given a reference to Atlantic Sugar, [1949] S.C.R. 706, at 711-712), whose amount "closely approximated" (para. 16) the total net value of its indirect U.S. investments at that time (i.e., including pre-2001 acquisitions), and were intended as hedges of those net investments (paras. 72, 3). Divestitures by some indirect U.S. subsidiaries in 2002 resulted in it being over-hedged, so that it terminated a portion of its swaps at that point. In 2003, GWL's debt/equity ratio had declined to approaching 1:1 (para. 90), and the U.S. dollar had depreciated to the point where further substantial declines were less likely. Accordingly, GWL terminated all its swaps, resulting in a gain of Cdn.$317 million.

This was a capital gain. Lamarre ACJ noted (at para. 81, see also 98) the principle that "in order to characterize the proceeds from a derivative transaction, one needs to identify the underlying item that created the risk … to which the derivative relates (which item does not necessarily need to be a transaction)" and that if, as was the case here, "it is found that the derivative was used to hedge a capital investment, any gain derived from the derivative will be on capital account." Furthermore, it was relevant that GWL was also "hedging" as this term was "understood under well-established business principles, including GAAP" (para. 92). The Crown position "which denies capital treatment … if there is no sale or proposed sale of the underlying item being hedged … has no legal basis" (para. 97), and "the settlement of derivative contracts in advance of their maturity date does not preclude those transactions from constituting a hedge (Echo Bay…)" (para. 88).

Unlike for Salada ("which was regularly speculating in currency" (para. 79)), the taxapyer had not entered into many other FX derivatives (paras. 24, 89) and the derivative here was a hedge and not speculative (paras. 70, 96, 97, 100). In particular, swaps, unlike futures and options, were unsuited to speculation due to their high initial transaction costs and lower liquidity (para. 106).

Locations of other summaries Wordcount
Tax Topics - General Concepts - Evidence hedge financing not an area of common knowledge 95

Saskferco Products Inc. v. The Queen, 2007 DTC 1183, 2007 TCC 462, aff'd 2008 FCA 297

loan repayments on capital account

In rejecting a submission of the taxpayer that foreign exchange losses on U.S. borrowings of the taxpayer were on income account because those U.S. dollar borrowings were hedged by a stream of U.S.-dollar revenues of the taxpayer, Woods J. stated (at para. 74):

The principle that a foreign exchange gain or loss on indebtedness takes its character from the character of the indebtedness has been followed in a long line of jurisprudence in this country and in the United Kingdom.

In the Court of Appeal, Evans JA stated (at para. 34):

The attribution of foreign exchange gains or losses on income account for tax purposes when income transactions are hedged by derivative contracts is an inadequate basis for extending them to commercially independent transactions and thereby departing from the well-accepted principle that foreign exchange losses on the repayment of a loan take their character from that of the loan itself.

CCLI (1994) Inc. v. The Queen, 2006 DTC 2695, 2006 TCC 240

borrowing to fund leasing equipment purchases on capital account

The taxpayer was found to have incurred foreign exchange losses on U.S.-dollar borrowing that were used by it to purchase railcars and aircraft for leasing purposes on capital account. Although the taxpayer carried on a financing business and although in Avco Financial Services Ltd. v. Federal Commissioner of Taxation (1982), 13 ATR 63 (Aust. (AC) hire purchase agreements were treated as being in the same category as money lending activities, in that case no borrowings were for the purpose of specific lending transactions whereas here, at the time the taxpayer borrowed the money, the borrowed money was earmarked to buy specific railcars or aircraft.

Imperial Oil Ltd. v. Canada; Inco Ltd. v. Canada, 2006 DTC 6639, 2006 SCC 46, [2006] 2 S.C.R. 447

capital loss on capital borrowing

Before finding that the taxpayers were not entitled to recognize deductions under s. 20(1)(f)(ii) at the time they repaid U.S.-dollar denominated debentures following an appreciation in the U.S. dollar, LeBel discussed Tip Top, Eli Lilly, Alberta Gas and Imperial Tobacco, and stated (at para. 45):

[T]he above cases stand for the proposition that foreign exchange gains and losses incurred in relation to foreign trade cannot be separated from the underlying transaction such that the foreign exchange gain or loss would be on capital account while the underlying transaction would be on income account. … The above cases are not of assistance in the cases at bar, where it is common ground that but for an express statutory provision, the foreign exchange loss would be on capital account because the borrowing was on capital account.

Federal Commissioner of Taxation v. Energy Resources of Australia Ltd., 94 ATC 4923, [1994] FCA 924 (Full Fed. Ct.)

short-term note facility on capital account

In order to refinance U.S.-dollar loans that it had received to finance the development of its mine, the Australian taxpayer negotiated a new Euronote facility pursuant to which it issued 90-day non-interest bearing promissory notes which were sold at a discount to members of a banking consortium who were successful in U.S. dollar tendering for the purchase of the notes to be issued, with the same procedure being repeated upon maturity of the notes. In finding that foreign exchange gains or losses were realized by the taxpayer on capital account, Hill J. stated (p. 4954):

"... [T]he funds borrowed were not used in or as an integral part of the profit-making activities of the taxpayer but in the financing of those activities. So seen, the exchange gains or losses were on capital account. The fact that the manner of borrowing, namely, through discounting of Euronotes, occurred with regularity so that, on the Commissioner's submissions, the exchange gains or losses occurred with the same frequency is not, of itself, sufficient, in my view, to characterise those gains or losses as being on revenue account. Ultimately, it is the purpose of the financing which will determine the character of the exchange gains or losses."

Netupsky v. The Queen, 92 DTC 2282, [1992] 2 CTC 2531 (TCC)

The taxpayer, who in addition to being a consulting engineer, also engaged in speculation in commodities and investment in revenue-producing apartments, borrowed Swiss francs pursuant to a demand loan that was secured through a fresh mortgage on a previously acquired Canadian rental property, and converted the Swiss francs into Canadian dollars for use in his commodity trading activities, which he treated as a business. In finding that the foreign exchange loss sustained by the taxpayer when he repaid the borrowing was a capital loss, Brule J indicated that the character of the loss as arising in connection with the taxpayer's trading business was not affected by the capital nature of the rental property.

Beauchamp v. F.W. Woolworth plc, [1989] BTC 233, [1989] UKHL TC_61_542 (HL)

In each of 1971 and 1972 the taxpayer borrowed 50m Swiss francs repayable in 5 years time (or earlier at the option of the taxpayer subject to a premium for early repayment), converted the Swiss francs to sterling and incurred a foreign exchange loss on repayment of the loans. The Special Commissioners found that the loss was deductible in light of the purpose of the borrowing, which was to deal with temporary cash flow difficulties in the taxpayer's retail trade.

The loss was incurred on capital account. "The temporary and fluctuating borrowings incurred in transacting business are revenue transactions." Here, however, there was a borrowing of a definite sum for a fixed term of 5 years; a borrowing which did not form part of the day to day activities of the taxpayer in earning income.

Overseas Containers (Finance) Ltd. v. Stoker, [1989] BTC 153 (C.A.)

The taxpayer ("OCFL") was incorporated as a subsidiary of a shipping company ("OCL") and interposed between OCL and German lenders in order to transmute foreign exchange losses on capital account into losses on income account. Since, having regard to the overall fiscal purpose of the group of the companies, the loan transaction entered into by OCFL had no commercial justification, the transaction was not a trading transaction, and the foreign exchange loss was realized by OCFL on capital account.

Pattison v. Marine Midland Ltd., [1983] BTC 448, [1984] 2 WLR 11 (HL)

A company which borrows foreign-currency funds and lends the same foreign currency funds to its customers will not realize a profit or loss [or, for that matter, a capital gain or capital loss] as a result of fluctuations in the relative value of the foreign currency if there has been no conversion of the foreign-currency funds into home-currency funds by the company. Unless such conversion occurs, the company is not at risk.

AVCO Financial Services Ltd. v. Federal Commissioner of Taxation, 82 ATC 4246, [1980] FCA 187 (HC)

Moneys borrowed in a foreign currency by a consumer finance company in the ordinary course of its business, i.e., for the purpose of lending the borrowed money by way of personal loans, hire-purchase-transactions and consumer mortgages, gave rise to foreign exchange gains and losses that were on revenue account.

International Nickel Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia (1977), 137 C.L.R. 347

The Australian taxpayer imported nickel products from England for purchase prices payable in sterling and generally paid for the goods after they were resold. The taxpayer realized an exchange gain on income account when the pound sterling was devalued in 1967, (even after taking into account a reduction in terms of Australian dollars of its receipts from its customers).

"Where income is assessed on an accruals basis, a purchase of stock in trade is taken into the books at the time when the purchase is made ... . However if in a subsequent income year, when the time for payment arrives, the taxpayer is compelled, because of a change in the rate of exchange, to expend a larger amount in Australian dollars in discharging his liability for the price than had already been allowed as a deduction, the additional amount which he is required to expend - the exchange loss - is an allowable deduction in that subsequent year." The same principles applied to foreign exchange gains.

Commercial and General Acceptance Ltd. v. Commissioner of Taxation (1977), 51 A.L.J.R. 842 (HC)

An Australian finance company realized a foreign exchange gain on capital account on the early repayment of U.S.-dollar borrowings from the Bank of America, notwithstanding that 65% of the borrowed funds were required under the terms of the loan to be kept in cash and money market instruments (which yielded a lower interest rate than the interest rate payable under the loan). "[T]he principal purpose of the borrowing was not to arm the taxpayer with more funds to lend or apply in the ordinary course of its finance business - thirty-five percent only of the loan could be so applied - but rather to provide a base of additional assets which would generally strengthen the taxpayer's financial standing ... . In these circumstances the principal purpose of the borrowing was to strengthen the business entity, structure, or organization set up or established for the earning of profit".

Caltex v. Federal Commissioner of Taxation (1960), 12 A.T.D. 170 (HC)

novation with new supplier not a realization event

The taxpayer, which was in the business of importing petroleum products and selling them in Australia, incurred a large U.S. dollar debt with an American affiliate (the "Old Supplier") for the purchase of such products over a period of years. When a new American affiliate was formed in 1936 (the "New Supplier") to be the sole supplier of the taxpayer, the New Supplier loaned dollars to the taxpayer which used the borrowed sums to pay off its indebtedness to the Old Supplier.

Dixon, C.J. found that "nothing has happened but the novation of a dollar indebtedness, or something equivalent or akin to a novation" and that, therefore, there was "nothing amounting to a realization or definite accrual or establishing of the loss."

Davies v. Shell Co. of China, Ltd. (1951), 32 TC 133 (CA)

Before agreeing to distribute its petroleum products through an agent in China, the taxpayer would require the deposit with it by the agent of a sum in Chinese dollars, which was repayable when the agency came to an end, and until then was available for making good any default of the agent under the agreement. When conditions in China began deteriorating in 1937, the taxpayer converted the deposits into sterling, and realized a foreign exchange gain when most of its 600 agency arrangements ultimately were terminated.

Jenkins L.J. characterized the deposits as being in essence loans by the agents to the taxpayer which formed a part of the taxpayer's fixed capital and noted (at p. 156) that:

"The mere fact that it was the Company's regular practice to appoint agents does not in my view invest the deposits taken from the agents with the character of trading receipts any more than the fact that it is the practice of a multiple trader to buy shops up and down the country whenever he sees fit to open a new branch invests his expenditure on such shops with the character of trade outgoings."

The gain was realized on capital account.

Administrative Policy

29 January 2015 Internal T.I. 2014-0544651I7 - Section 85 transfer of Swap Contracts

swap contract treated as inventory

CRA found that cross-currency swaps with accrued gains, which for redacted reasons were considered to be held on income rather than capital account, qualified as "inventory" under the broad s. 248(1) definition, so that they could be transferred on a rollover basis into subsidiaries under s. 85(1). See summary under s. 85(1.1).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 248 - Subsection 248(1) - Inventory swap contract treated as inventory 55
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1.1) swap contract treated as inventory 180
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1) swap contract recorded on securities rather than inventory line of T2057 251

28 May 2015 IFA Roundtable Q. 1, 2015-0577691C6 - IFA 2015, Q.1: George Weston decision

GWL required sufficient linkage to underlying capital assets

How does GWL impact CRA's position on foreign currency hedges for net investments in foreign operations? CRA responded:

The CRA accepts… GWL. While the decision affirmed that there are circumstances in which a foreign currency derivative can be considered a hedge of a taxpayer's net investments in foreign operations there must, however, be evidence that demonstrates that the derivative is sufficiently linked to the underlying capital assets. …

… The Court concluded that the taxpayer would not have entered into the swaps if it had not acquired the US Operations. …[T]he notional value of the swaps closely approximated the investments in the US Operations, the taxpayer's formal derivative policy and its credit facilities prohibited it from speculating in derivatives, and… there was no evidence that the swaps were related to an underlying item that was on income account …[nor] of a profit or speculation motive… .

The Court did not consider the early termination of the derivative in these circumstances, to cause the derivatives to be considered speculative in nature. The termination occurred after the taxpayer's risk had declined (its debt to equity ratio had returned to acceptable levels) and the derivatives were no longer required to protect GWL's capital structure.

5 March 2014 Internal T.I. 2013-0500891I7 - Hedging

s. 85(1) roll of FX forward to sub

Parent hedged a U.S.-dollar borrowing by entering into foreign currency forward contracts. In order to utilize capital loss carryforwards of a wholly-owned subsidiary ("Subco"), it assigned its rights and obligations under the forward contracts to Subco, and they elected under s. 85 for rollover treament. Subco then received a cash payment on settlement of the forward contracts. CRA first found that the forward contracts were capital property to Parent:

While the hedge was put in place a few years after the issuance of the debt, the aggregate amount of the forward contracts was similar in amount to the debt and the maturity date of the contracts matched the maturity date of the debt.

CRA then applied the following statement at the 1983 Roundtable to confirm that Subco's gain was on capital account:

We…are prepared to accept the 85(1) roll and would also accept that the profit would still be a capital gain, despite the short holding period, where the roll was between two sister corporations or a parent and its controlled subsidiary and the ultimate sale was to an arm's length third party.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 85 - Subsection 85(1.1) s. 85(1) roll of FX forward to sub 110
Tax Topics - Income Tax Act - Section 9 - Capital Gain vs. Profit - Futures/Forwards/Hedges s. 85(1) roll of FX forward to sub 195

26 June 2013 External T.I. 2013-0481691E5 - Hedging - ITA 39(2)

no linkage in maturity dates of FX forwards and "hedged" debt

In order to hedge for accounting purposes a foreign currency debt of the taxpayer owing to related parties, the taxpayer entered into foreign currency forward contracts which were settled and re-entered into on a monthly basis and whose amounts were equal to the principal portion of the loan outstanding or (latterly) such principal plus interest. The taxpayer deducted losses on the forward contracts on income account, and reported a capital gain when the debt was settled (on a refinancing) after four years.

In agreeing with the income-account treatment, and after referring to the exact matching of the maturity dates in Shell, CRA stated:

the maturity dates of the forward contracts do not in any way correspond to the date of the underlying transaction on which the risk was anticipated to materialize. It appears that the hedges were put in place independently of any expectation of realizing a gain or loss on the settlement of the debt. Thus, there is no linkage between the maturity dates of the foreign currency contracts and any actual or intended date of settlement of the debt.

21 December 2012 Internal T.I. 2012-0465561I7 - Hedging transaction

hedge of CFA's debt on income account

A foreign affiliate having the euro as its unit of measure borrowed in U.S. dollars. In order for the FX risk to be transferred to the taxpayer, it and the taxpayer entered into a hedging contract under which annual payments were made based on annual changes in the euro equivalent of the loan. In finding that the gain realized by the taxpayer in a year as a result of such an annual settlement was on income account, CRA noted that in Salada Foods v. The Queen, 74 DTC 6171 (FCTD), "the taxpayer did not convince the court that the hedge transaction was sufficiently integrated with the underlying capital risk it purported to hedge," and stated that here:

[T]here is insufficient linkage which would tie the foreign exchange gain [of the taxpayer]….to any underlying capital transaction…[such as] a purchase, a sale, or a repayment of debt. In this case, the Loan was not [the taxpayer's] debt but that of [the foreign affiliate]. Accordingly, the foreign exchange transaction was a speculation made in the hope of profit, which would be treated as an adventure in the nature of trade, and any gains should be taxed as business income.

12 October 2010 Internal T.I. 2010-0367611I7 - Cross Currency swap - Income or Capital

FX swap to hedge dividend-funding loan

Canco, which was a wholly-owned subsidiary of a US-resident public-company parent (Parent), borrowed in a foreign currency from Sisterco (a non-resident wholly-owned subsidiary of Parent) in order for it to pay a dividend to Parent. In order to hedge its currency risk under the loan from Sisterco, Canco entered into cross-currency swap agreements with Canadian banks, involving an exchange of periodic notional interest payments, and a notional exchange of principal amounts on maturity, in the two currencies.

CRA stated:

...the gain or loss computed in reference to the settlement of a hedge is characterized for tax purposes depending upon the transaction being hedged. Therefore, in this case, since we have a loan to Sisterco as the underlying transaction, the loan would be considered on capital account since it was for the purpose of paying a dividend. In our view, the gain or loss realized on the settlement of the hedge would also be on capital account.

30 October 2008 Internal T.I. 2008-0297081I7 - Foreign Exchange

general corporate borrowing on income account

"Generally, if funds are borrowed for general corporate purposes, gains are probably on account of income unless it can be demonstrated that the company was 'grossly' undercapitalized in which case the gains will be on account of capital ... Where the realization of investments is part of the corporation's ordinary business, the resulting gains or losses would normally be on income account."

2004 Ruling 2004-008527

leased equipment financing on income account

A company that leases equipment in the ordinary course of business and funds the purchase of the leased equipment out of its general pool of funds rather than out of specific borrowings will treat foreign exchange gains or losses incurred to fund the cost of the equipment as being on income account.

23 February 2004 External T.I. 2003-0048121E5 F - Paiement reçu - annulation d'un contrat

surrogatum principle applied to FX hedging termination payment

Regarding whether an amount received by a corporation on the cancellation of FX hedging contracts that it had used to provide some protection for the conversion into Canadian dollars of revenues obtained from the sale of its manufactured products to American customers, CRA referred to Canadian National Railway and Schofield Oil as establishing that the nature of the amounts received as business income or a capital gain turned on the nature of the amounts that the termination payment was intended to replace.

28 January 2004 External T.I. 2003-0028891E5 F - Perte sur change relative à des contrats de change

CGE established that accrued loss on FX forward contract is not a contingent liability

A corporation had an accrued foreign exchange loss on foreign exchange contracts that it had entered into to hedge its food-sale operations in the US and that matured in the following year. After noting that the corporation’s recognition of such losses in accordance with GAAP and its financial statement treatment accorded with IT-346R, para. 14 and IT-95R, paras. 7 and 8, CRA went on to state that deduction of the losses nonetheless would be denied under s. 18(1)(a) if the obligation to pay under the forward contract had not yet arisen, or under s. 18(1)(e) if there was “uncertainty as to the payment of the debt.” Regarding the latter test, it stated:

In the case of a forward obligation, there is therefore certainty as to the payment of the debt, only the time of payment is deferred. It is, however, a real and enforceable debt and therefore a true obligation within the meaning of the above-mentioned Interpretation Bulletins and decisions (for an example of such an obligation in the context of a foreign exchange loss, see … Canadian General Electric … .

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(1) - Paragraph 18(1)(e) CRA position regarding recognition of accrued income account losses is subject to any application of ss. 18(1)(a) and (e) 206

16 December 1991 Memorandum 903636 [general principles]

general principles

(a) Where a taxpayer acquires foreign exchange, borrows foreign exchange on current account or becomes indebted in a foreign currency as a result of trading transactions, any resulting foreign exchange gain or loss will be on income account. (Tip Top Tailors Limited v MNR (1957) CTC 309; Aluminium Union Ltd. v MNR (1960) CTC 206, confirmed (1963) DTC 1254)

(b) A gain or loss on a loan forming part of the fixed capital of a business is on capital account. (Columbia Records of Canada Ltd. v MNR (1971) DTC 5486)

(c) Where the proceeds of a foreign currency loan are used to acquire capital assets, there is a strong presumption that any resulting foreign exchange gain or loss is on capital account. (Alberta Gas Trunk Line Company Limited v MNR (1971) DTC 5403; Neonex International Ltd. v the Queen (1978) CTC 485)

(d) Funds derived from a company's trading activities may acquire a capital character if they have been clearly set aside for capital purposes. (Ethicon Sutures Ltd. v the Queen (1985) 2 CTC 6)

(e) Gains and losses on capital may not be recognized for income tax purposes until realized. Gains and losses on income account may be recognized on either a realized or accrual basis provided one such method is followed consistently. (Canadian General Electric Co. Ltd. v MNR (1961) DTC 1300)

29 January 1999 Internal T.I. 9900477 - FOREIGN CURRENCY, 85(1) ROLLOVER

U.S. currency used in operations

U.S. currency that was transferred to the taxpayer by its parent under s. 85(1) would give rise to an income account gain if at the time of the disposition the U.S. dollars were used in the taxpayer's operations.

30 August 1995 External T.I. 9520955 - DEDUCTIBILITY OF AN EXCHANGE LOSS

borrowing for capital purpose on capital account

With respect to a foreign exchange loss realized by a corporation on refinancing both current and long-term U.S.-dollar liabilities, RC stated that "where a borrowing is used for a capital purpose ... subsection 39(2) of the Act applies".

18 September 1995 Internal T.I. 9427166 - FOREIGN EXCHANGE GAINS AND LOSSES

general purpose borrowings on capital account unless under-capitalized

Before a detailed discusson of the jurisprudence, the writer indicated that, in general, gains derived from currency revaluations of foreign currency borrowing that are used for general corporate purposes will be on account of income, but went on to add this important qualifier: "the courts have found, however, that in circumstances in which the taxpayer is under capitalized and, consequently, unable to carry on its business without the borrowed funds, any exchange gain or loss realized in respect of those funds will be on account of capital regardless of the intended or actual use of the funds".

Revenue Canada Round Table TEI, 16 May 1994, Q. 11 (C.T.O. "Foreign Exchange Gains and Losses")

The use to which funds borrowed in a foreign currency have been put will be a factor in determining the nature of any gain or loss incurred or realized with respect to a forward contract used to hedge any exchange exposure relative to that borrowing.

There are no specific criteria for determining whether foreign currency borrowings form part of the fixed or permanent capital of the borrower.

10 March 1992 T.I. (Tax Window, No. 17, p. 21, ¶1798 )

Where a foreign currency borrowing is hedged with a foreign currency swap, the offsetting gain or loss and the receipt of the principal swap and the repayment of the foreign currency loan will be treated on a consistent basis.

Both payments and receipts in respect of interest rates swaps are an income account.

16 December 1991 Issue Sheet (Tax Window, No. 11, p. 21, ¶1540)

Summary of RC views on the foreign exchange gain case law.

19 April 1990 T.I. (September 1990 Access Letter, ¶1414)

Where Canadian residents, who are members of a partnership doing business in the U.S., enter into currency futures contracts to close on the anticipated date of distributions from the U.S. partnership in U.S. dollars, the hedge transaction will be considered to be a separate transaction from the distribution, and the hedge transaction will be characterized as a capital transaction if the partners hold their partnership interests as capital property and are not in the business of buying and selling currency futures contracts - unless they have elected as subscribed in IT-95R, para. 6.

88 C.R. - "Finance and Leasing" - "Hedging Transactions"

The Rulings Directorate has initiated a study of interest rate and foreign currency hedging transactions.

84 C.R. - Q. 60

amounts payable or receivable by Canco to or from a financial intermediary under a coupon swap, or a basic currency swap transaction, will be on income account provided (in the case of the coupon swap) that the interest payable by Canco on its debt was deductible. The gain and loss on maturity of the currency swap off-set.

84 C.R. - Q.63

Whether the gain or loss on the fulfillment of a forward contract will be realized on capital or income account depends on the underlying use of the funds that gave rise to the liability.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 54 - Adjusted Cost Base 26

IT-270R2 "Foreign Tax Credit" under "Amount Paid by the Taxpayer for the Year"

Overpayments of foreign taxes implicitly are treated as capital debts.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 39 - Subsection 39(2) 13


Broadhurst, "Foreign Exchange Planning", 1993 Corporate Management Tax Conference Report, c. 8.

Stephen S. Ruby, "Recent Financing Techniques", 1989 Conference Report (CTF), C. 27 [cited in Shell, supra].

FX forward and hedged debt result in separate gain or loss (p. 27:12)

Where a foreign currency liability is hedged, the department, as stated above, adopts the view that the hedge and the liability are separate transactions rather than a single integrated transaction composed of two parts. [fn 17: The separate transaction approach was approved of recently in MacMillan Bloedel Limited v. The Queen, 90 DTC 6219 (FCTD). See also Cockshutt Farm Equipment of Canada Ltd. v. MNR, 66 DTC 44 (TAB).] Accordingly, the department's view is that the closing out of the forward contract constitutes a separate transaction from the satisfaction of the foreign currency liability that the forward contract is hedging. Therefore, the closing out of the forward contract itself will result in a foreign exchange gain or loss, as will the satisfaction of the foreign currency liability.

Hedge establishes cost of acquired currency (p. 27:12)

It is arguable, however, that the settlement of the forward foreign exchange contract does not result in the crystallization of a foreign exchange gain or loss but merely sets the Canadian dollar price of the foreign currency obtained on the closing out of the contract. [fn 18: For useful articles in this area see David G. Broadhurst, "Income Tax Treatment of Foreign Exchange Forward Contracts, Swaps, and Other Hedging Transactions".] On this approach, any foreign exchange gain or loss that arises in respect of the foreign currency would be recognized only when the currency is disposed of….