Principal Issues: [TaxInterpretations translation] Does the repayment of a U.S. money debt owed by a partnership to its partners entail computing a capital gain or loss?
Position: The position in Interpretation Bulletin IT-95R is that the repayment of a debt is a transaction that may give rise to a capital gain or loss even though no Canadian currency was used to make the repayment. The amount of the repayment expressed in Canadian currency at the exchange rate in effect at the time of repayment will be compared to the amount of the advance expressed in Canadian currency at the exchange rate in effect at the time the advance was made. We have not changed our position following the Supreme Court's obiter dictum in Imperial Oil.
Reasons: Paragraph 13 of Interpretation Bulletin IT-95R and previous positions.
August 29, 2007
Pierre C. Leduc Headquarters Large file auditor 444-2-1 Income Tax Rulings Directorate Montreal Tax Services Office 305 René-Lévesque Blvd. West Sylvie Labarre Montreal QC H2Z 1A6 2007-021993
Exchange rate loss - partnership
This is in response to your internal memo of January 5, 2007, in which you asked for our opinion on the impact of foreign exchange on certain balance sheet items of a US partnership.
Facts
Advances due to partners
Canco is a Canadian corporation that holds a 50% interest in a US partnership that is not a limited partnership. The second partner, who also holds a 50% interest, resides in the United States. There is an arm's length relationship between the two partners. The operations of the partnership are carried on in the United States.
In the first year, the Canadian partner and the US partner both advanced US$1,000,000 to the partnership. The exchange rate for the Canadian dollars at that time was 1.20. In the third year, the advances owing to the partners were converted into units in the partnership. The Canadian dollar exchange rate at that time was 1.40.
Real property
Canco owns real property located in the United States. The partnership of which Canco is a partner also owns real property located in the United States.
Questions
What are the tax consequences to Canco of the repayment of the advances owing to the partners by the partnership through the issuance of units in the U.S. partnership? What is the impact of this transaction on the adjusted cost base of the partnership interest held by Canco?
For Canco, what are the differences in computing income from real property between real property held directly and real property held through a partnership?
Our Comments
Our position is that a taxpayer's transactions should be measured in Canadian currency either at the time of the transaction or at a time that would produce substantially the same results as if we had converted the transaction to Canadian currency at the time it occurred.
Paragraph 96(1)(a) of the Income Tax Act (the "Act") provides that the amount of income, non-capital loss, and net capital loss of a member of a partnership shall be computed as if the partnership were a separate person resident in Canada. It is therefore our view that the position referred to in the preceding paragraph would apply to the partnership and that transactions entered into by the partnership in U.S. dollars should be converted into Canadian currency at the time referred to in that position.
Interpretation Bulletin IT-95R provides some guidance on computing foreign exchange gain or loss. Paragraph 8 of that Bulletin provides further details on our position on the translation of income transactions.
Advances due to the partners
We have also assumed that the funds advanced by the partners in this situation are part of the capital since the taxpayer has treated the exchange rate loss as a capital loss.
In such a case, it would be necessary to determine whether subsection 39(2) applies when repaying advances made to the partnership by its members. Since subsection 39(2) is part of the income calculation, it applies at the partnership level. Paragraph 13 of Interpretation Bulletin IT-95R states that the Canada Revenue Agency (CRA) considers that a taxpayer has "made a gain" or "sustained a loss" in a foreign currency only where there has been a transaction resulting in a gain or loss and that subsection 39(2) does not apply where a loss has been made "on paper" but no transaction has taken place. The same paragraph of IT-95R gives examples of times when the CRA considers a transaction to have taken place and specifically states as a time, the time of repayment of all or part of a capital debt obligation.
As set out in Interpretation Bulletin IT-95R, the repayment of advances due to partners would represent a transaction that could result in a foreign exchange gain or loss. The amount of the repayment in Canadian currency would then have to be measured at the exchange rate in effect on the date of repayment and the amount of the advances in Canadian currency would have to be measured at the exchange rate in effect on the date the advances were made in order to determine the foreign exchange gain or loss, the difference between the two amounts being the gain or loss referred to in subsection 39(2). Our position has not changed as a result of the Supreme Court's obiter dictum in Her Majesty the Queen v. Imperial Oil Limited; Her Majesty the Queen v. Inco Limited, 2006 DTC 6639 regarding the recognition or non-recognition of a foreign exchange gain or loss on repayment of a debt and of the Gaynor case and related British case law.
In this situation, we are left with a capital loss of $400,000. Pursuant to subsection 96(1)(f) of the Act, the Canadian partner will be allocated 50% of the partnership loss, or $200,000, as a capital loss.
Furthermore, the Canadian partner will be required to compute its gain or loss from the disposition of its investment. For purposes of this discussion, we have assumed that the investment is capital property. For purposes of computing the capital gain or loss on the disposition of the investment, the proceeds of disposition of the advance will be measured in Canadian currency using the exchange rate on the date of disposition and the adjusted cost base will be measured using the exchange rate on the date the advance was made to the partnership. In this situation, the disposition of the Canadian partner's investment results in a capital gain of $200,000.
Thus, the capital gain on the disposition of the investment by the Canadian partner will be reduced by the capital loss allocated to it by the partnership.
The cost of the units acquired in consideration for the extinguishment of the advance owed to the Canadian partner will be equal to the amount of the advance measured in Canadian currency at the time of issuance of such new units. Thus, the $200,000 capital gain realized on the disposition of the investment will be reflected in the adjusted cost base. On the other hand, the adjusted cost base of the Canadian partner's interest in the partnership will be reduced by the capital loss allocated to it by the partnership of $200,000 pursuant to 53(2)(c)(i).
Since the adjusted cost base of the partnership interest after the conversion will be the same as the adjusted cost base of the advance and the partnership interest before the conversion, and the Canadian partner does not benefit from an overall capital loss, there is no advantage to acquiring the interest by first making an advance to the partnership.
Real property
If real property is held by a partnership, the income will be computed as if the partnership were a separate person resident in Canada. A Canadian partner's share of the income will be allocated to that partner as a result of that computation.
Assuming that the real property is held directly by Canco in the same proportions as its percentage interest in the partnership, there is no distinction in the measurement of Canadian currency transactions whether the real property in the United States is held directly by Canco or by the partnership of which Canco is a member. The positions outlined in Interpretation Bulletin IT-95R will be applied in the same manner. Thus, the financial statements of the partnership will have to be measured in Canadian currency and the transactions of the partnership will have to be expressed in Canadian currency.
Where the real property (a building) is held by a partnership, the capital cost allowance is calculated by the partnership. The restrictions on the capital cost allowance, if any, that may be provided by the Income Tax Regulations will be applied to the partnership as if it were a person. Consequently, there may be circumstances where the capital cost allowance deducted by the partnership will not be the same as the capital cost allowance that would have been deducted by the partner if it had held the real property directly. On the other hand, there will be no distinction in the capital cost of the real property used to calculate the capital cost allowance between the property held directly by Canco and the property held by the partnership. Paragraph 9 of Interpretation Bulletin IT-285R2 will apply. Paragraph 9 of IT-285R2 provides that the original cost of the real property will be expressed in Canadian dollars, using the exchange rate in effect at the date of acquisition of the real property unless a deposit was made on the purchase price.
We hope that these comments are of assistance. Should you require further information on the content of this letter, please do not hesitate to contact us.
Alain Godin,
Manager
for the Director
International Operations and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.