Principal Issues: [TaxInterpretations translation] With respect to three scenarios, what is the tax treatment resulting from a foreign currency fluctuation?
Position: See our responses in the letter.
Reasons: The Income Tax Act.
XXXXXXXXXX 2009-035050
June 27, 2011
Dear Madam,
Subject: Foreign exchange gains and losses
This is in response to your letter of December 3, 2009 in which you asked for our opinion regarding the calculation of foreign exchange gains and losses in three examples. We apologize for the time required to answer your question.
Unless otherwise indicated, all statutory references herein are to the provisions of the Income Tax Act (the "Act").
In particular, you submitted the following three scenarios that include foreign exchange transactions:
(1) A Canadian corporation carrying on an active business acquires capital property at a cost of U.S.$90,000 and pays the purchase price immediately.
(2) The same corporation acquires the same capital property but pays the purchase price 30 days after the acquisition. At the time of purchase, the exchange rate was Cdn.$1.10 while at the time of payment, the exchange rate was Cdn.$1.11.
(3) The same corporation, prior to the acquisition of the property, converted Cdn.$99,000 into U.S. dollars at a time when the exchange rate was Cdn.$1.10. When the company makes the payment of the sale price to the supplier, the exchange rate is Cdn. $1.12.
Although we do not clearly discern the differences between the second and third scenarios, we provide the following comments.
Our Comments
It appears to us that the situation described in your letter and hereinafter summarized could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R5, it is not the practice of this Directorate to provide comments on proposed transactions involving specific taxpayers otherwise than in the form of an advance income tax ruling. If your situation involved specific taxpayers and one or more transactions, you should submit all relevant facts and documents to the appropriate Tax Services Office for their opinion. However, we are able to offer the following general comments that may be helpful to you.
Interpretation Bulletin IT-95R, Foreign Exchange Gains and Losses, outlines the overall position of the Canada Revenue Agency with respect to transactions that may result in a gain or loss due to fluctuations in the value of foreign currencies.
In a capital disposition, it is necessary to calculate the gain or loss from the disposition as a whole. If the gain or loss, as calculated in section 40, is solely attributable to the fluctuation of the value of a foreign currency relative to the Canadian currency, then it is subsection 39(2) that will apply in respect of the gain or loss. In the scenarios that you described, we believe that any foreign exchange gain or loss is governed by subsection 39(2).
Subsection 39(2) applies to any fluctuation, after 1971, in the value of a foreign currency relative to Canadian currency that results in a gain or loss. The CRA considers that a taxpayer has realized a gain or loss in a foreign currency only in cases where there has been a transaction resulting in a gain or loss. Subsection 39(2) does not apply where a loss has been made on paper but where there is no transaction. For that reason, the accrual accounting method for foreign exchange gains or losses is not accepted for the purpose of reporting foreign exchange gains or losses on capital.
The following are examples of where the CRA considers a transaction to have occurred and that subsection 39(2) applies:
a) the date on which the conversion of funds from one foreign currency into another foreign currency or into Canadian dollars takes place,
b) the date on which foreign currency funds are used to make a purchase or payment (in which case the gain or loss is the difference between the value of the foreign currency expressed in Canadian dollars when it is realized and its value expressed in Canadian dollars when the purchase or payment has occurred), and
c) the date of repayment of part or all of a debt.
In this case, we believe that subsection 39(2) applies to the three scenarios that you have presented to us. In the first scenario, no gain or loss on foreign exchange would be recognized. In the second scenario, we believe that the corporation would realize a capital loss of $900.00 under subsection 39(2) while, for the third scenario, a gain of $1,800.00 would be realized under paragraph 39(2).
As stated in 2007-0234691I7, the capital gain or loss arising from the application of subsection 39(2) can only be determined at the end of the taxpayer's taxation year and only after considering all foreign exchange gains/losses realized/incurred in that taxation year. Consequently, the capital gains or losses resulting from subsection 39(2) will only affect the balance of the capital dividend account at the end of the taxpayer's taxation year.
We hope that these comments are of assistance.
Best regards,
François Bordeleau, Advocate
Manager
Business and Partnerships Section
Income Tax Rulings Directorate