Swaps

Before going on to indicate that it no longer imputed interest on mismatched cross-border swap payments, CRA stated:

As set out in various of its publications, the CRA considers that all amounts payable or receivable under the terms of a swap agreement are on account of income and are to be included or deducted under section 9. This is consistent with the CRA's long-standing position that payments under a swap agreement do not have a specific character for legal purposes. Thus, as a matter of law, payments under a swap agreement are not interest, dividends, rents, royalties or payments for services or proceeds of disposition, nor do they represent a substitute for a legal obligation to pay such amounts.

A receipt received by a taxpayer on the termination of a floating-to-fixed interest rate swap was not a capital receipt given that (applying the jurisprudence) the termination of such contract did not entail the destruction of its whole profit-making apparatus or even a serious dislocation of its normal commercial organization. Furthermore, here "it is the interest on the debt and not the foreign currency denominated debt itself which is the subject of the hedge."

The CRA position that all amounts payable or receivable pursuant to an interest rate swap agreement (including a termination payment) will be considered to be on income account, reflects its "longstanding position regarding interest rate swaps ... based on the fact that the swap agreement is a separate legal contract (whether or not the swap is used as a hedge)" and is consistent with the decision in Shell (99 DTC 5699).

After defining a "plain vanilla" interest rate swap agreement as one where there was no timing mismatch regarding the notional payments going each way, CCRA stated that "all amounts payable or receivable, including termination payments, pursuant to a plain vanilla interest rate swap agreement will be considered to be on account of income and will be included in or deductible from the income of the taxpayer pursuant to section 9."

Swap payments deducted by the taxpayer under s. 9 were, in large part, incurred to acquire a right under a contract to purchase Japanese yen at the termination of the swap agreement at a rate which was more favourable than the exchange rate the market was predicting at the time the agreement was entered into. The cost of such a right would be included in the computation of the gain or loss on a hedge in respect of the principal amount of the loan. Whether that gain would be on income or capital account would depend on the characterization of the underlying debt obligation to which the hedge related.

The responses contained in Q.60 of the 1984 Revenue Canada Round Table continue to reflect the position of the CCRA.