Principal Issues: [TaxInterpretations translation] 1. Does the position set out in paragraph 13 of Interpretation Bulletin IT-95R that foreign funds on deposit may be moved from one form of deposit to another as long as such funds can continue to be viewed as "on deposit" without being considered to be disposed of apply in this situation?
2. A capital investment has been made in the form of a debt. On repayment of the obligation, there is a disposition of the investment. At what exchange rate should the proceeds of disposition and the adjusted cost base be converted?
3. Is a loss on a non-interest-bearing debt or loan investment to a parent corporation deemed to be nil?
Position: 1. We are of the view that the position with regard to money on deposit does not apply to the present situation and that the funds have been used to acquire other property.
2. The proceeds of disposition will be converted at the exchange rate at the time of the repayment and the adjusted cost base will be converted at the exchange rate on the date of the transaction.
3. Yes
Reasons: 1. The taxpayer has used its funds to acquire investments in debt or loans from related entities that are not financial institutions.
2. Principle stated by the Federal Court of Appeal in Hope R. Gaynor.
3. Subparagraph 40(2)(g)(ii) of the Act. The investment in the parent corporation was not made for the purpose of earning income from a business or property.
September 4, 2007
Marcel Dionne Headquarters Large Business File Section 441 Income Tax Rulings Directorate Montreal Tax Services Office 305 René-Lévesque Blvd. West Sylvie Labarre Montréal QC H2Z 1A6 2007-023779
XXXXXXXXXX
This is in response to your internal memo of May 29, 2007, in which you requested our opinion on the foreign exchange gain or loss to be taken into account by XXXXXXXXXX (the "taxpayer") in computing its income.
Facts
The taxpayer has a US dollar bank account into which it deposits US dollars from its sales and from which it lends US dollars to affiliates. Those loans are repaid to the taxpayer in US currency, which it deposits in that bank account. All of those transactions take place without converting the currency into Canadian money.
The taxpayer has made loans to XXXXXXXXXX. Those transactions are of a capital nature to the taxpayer.
XXXXXXXXXX is the taxpayer's parent corporation. It does not pay interest on its loans.
The taxpayer made loans of a few months' duration to XXXXXXXXXX in XXXXXXXXXX and calculated the foreign exchange gain or loss using the average exchange rate for the month for loans and repayments. On the other hand, the taxpayer made loans of a few days' duration to XXXXXXXXXX at each quarter end of XXXXXXXXXX and calculated the foreign exchange gain or loss from those loans using the daily rate for loans and repayments in XXXXXXXXXX whereas in XXXXXXXXXX, the taxpayer used the daily rate for repayments and the average rate for the month for loans.
The taxpayer's representative argues that it should not calculate a foreign exchange gain or loss because of our position in paragraph 13 of Interpretation Bulletin IT-95R which reads as follows:
Foreign currency funds on deposit are not considered to be disposed of until they are converted into another currency or are used to purchase a negotiable instrument or some other asset, i.e. foreign funds on deposit may be moved from one form of deposit to another as long as such funds can continue to be viewed as "on deposit". Term deposits, guaranteed investment certificates and other similar deposits which are in fact not negotiable, are considered funds on deposit. …
According to the taxpayer's representative, the loans made are money that remains on deposit.
You do not agree with the taxpayer's representative. You are of the opinion that the funds were used for investment in marketable instruments such as notes, bonds, debentures, etc. and that there should be a calculation of the foreign exchange gain and loss when the loans receivable are repaid.
With respect to the exchange rate to be used, you are of the view that the use of the daily rate on the date of the transaction to determine the adjusted cost base and proceeds of disposition is consistent with the principles set out in Hope R. Gaynor v. The Queen, FCA, 91 DTC 5288, from which the following extract is taken:
Once that is realized, it becomes clear that the cost of the securities to the appellant must be expressed in Canadian currency at the exchange rate prevailing at the time of their acquisition while the valuation of the proceeds of disposition of the same securities must be made in Canadian currency at the rate of exchange prevailing at the time of the disposition.
Questions
1. Should the taxpayer calculate a foreign exchange gain or loss on the use of the funds to lend to its affiliates and on the repayment of the debt or loan investments made by the taxpayer?
2. What rate should the taxpayer use to convert the loans and repayments into Canadian dollars?
3. Is the taxpayer's loss in respect of the debts or loans owed by and repaid by XXXXXXXXXX deemed to be nil because of subparagraph 40(2)(g)(ii) of the Income Tax Act (the "Act")?
Our Comments
With respect to the first question, your arguments and those of the taxpayer's representative are based on your respective interpretations of the term "negotiable instrument" as used in paragraph 13 of Interpretation Bulletin IT-95R (hereinafter the "Bulletin"). Since paragraph 13 of the Bulletin is not intended to be a statute but an interpretation of what constitutes the time of realization of a capital gain or loss on foreign exchange, we do not believe that the authors of the Bulletin, which was issued on December 16, 1980, used the phrase "negotiable instrument" in that paragraph with a specific and limited meaning in mind. In any event, that sentence in the Bulletin is supplemented by the phrase "or some other asset". Thus, the use of foreign currency funds that could result in a foreign exchange gain or loss is not limited to the acquisition of negotiable instruments but also covers the acquisition of any other asset. We are of the view that receivables or loans made by the taxpayer represent property of the taxpayer.
Rather, it should be determined whether the money is on deposit and whether the position taken in the excerpt quoted above with respect to money on deposit applies. In our view, the above position with respect to money on deposit does not cover situations where an investment in the form of a debt or loan, as in this situation, is acquired from an entity other than a financial institution. Consequently, the foreign currency funds would have been disposed of when the funds were used to acquire the debt obligation or loan. That disposition could result in a capital gain or loss pursuant to subsection 39(2). Furthermore, we are of the view that the taxpayer may realize a capital gain or loss when the debt or loan investments in its affiliates are repaid to the taxpayer since the repayment of a debt obligation is a disposition of property.
In response to your second question, we agree with you that the excerpt from the Gaynor decision on which you rely is relevant to the present situation. Thus, in calculating the capital gain or loss resulting from the repayment of the debt or loan, the proceeds of disposition would be converted to Canadian currency using the exchange rate at the date of repayment and the adjusted cost base would be converted to Canadian currency using the exchange rate at the date of the loan. Our Directorate has never taken an administrative position that the CRA would accept conversion rates different from those in Gaynor for transactions of a capital nature.
In response to your last question, it is our view that subparagraph 40(2)(g)(ii) could indeed apply to deem any capital loss on the disposition of the debt or loan that was owed by the taxpayer's parent corporation to be nil since the debt was not acquired for the purpose of gaining or producing income from a business or property, as the debt is non-interest bearing.
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.