Canco’s 2014 financial statements were reported in U.S. dollars (USD) in the consolidated financial statements of its U.S. parent.. Canco made a valid election under s. 261(3)(b) to report its income in USD effective the start of its 2015 taxation year, and purportedly converted its retained earnings (“R/E”) at the December 31, 2014 relevant spot rate. The resulting “R/E for Canadian income tax purposes [were] less than its R/E for financial statement purposes… .” On this basis, Canco intends to report a one-time foreign currency loss in 2015 of this difference. Is this approach correct?
In rejecting this approach, CRA first indicated:
[W]hile an electing corporation may have been calculating its financial statements in its elected functional currency, section 261 does not refer or rely on these amounts in converting CAD Year Amounts or amounts related to CAD Year Debts to the corporation’s elected functional currency.
As well, there is nothing in section 261 to provide for any adjustment to amounts to reconcile them with what the amounts would have been had the corporation always reported its income under the Act in its elected functional currency. Instead, conversions are made as of the time the conversion takes place using the relevant spot rate at that time. As such, no immediate income consequences result.
and later stated “that not recognizing any gain or loss on the making of a functional currency election is consistent with our understanding of the tax policy.”
Turning specifically to the R/E, it first noted that s. 261(7)(h) referred to the conversion of an amount “that is relevant in determining the Canadian tax results,” and stated:
[F]or determining a taxpayer’s [thin cap] limitation…the R/E used would be the opening R/E taken from the corporation’s USD financial statements used for financial reporting. As such it is our view that R/E in Canco’s last Canadian currency year is not relevant in determining the Canadian tax results for its first elected functional currency taxation year and, consequently, is not to be translated pursuant to paragraph 261(7)(h)… .