Principal Issues: A private corporation ("Holdco") has sustained foreign exchange losses by reason of various dispositions of securities and commercial papers during a certain taxation year. Holdco has also sustained foreign exchange losses by reason of the disposition, upon maturity, of commercial papers. Holdco held the securities and commercial papers as capital properties. Whether subsection 39(1) or subsection 39(2) applies with respect to these foreign exchange losses. What is the impact of these foreign exchange losses on Holdco's capital dividend account ("CDA")?
Position: CRA's position is that in reference to a gain or loss from the disposition of property, subsection 39(2) will apply only if the gain or loss is solely attributable to the fluctuation of the currency of a country other than Canada relative to Canadian currency. If the gain or loss is not solely attributable to the fluctuation in the value of currency, then subsection 39(1) should be used in computing the capital gain or capital loss. Considering the above, subsection 39(1) should have applied with respect to the dispositions of securities and commercial papers (other than those disposed upon maturity). Consequently, the capital gain (or loss) realized (sustained) by Holdco by reason of such dispositions would have affected Holdco's CDA at the time of the disposition, and not at the end of the relevant taxation year. However, it seems that subsection 39(2) should have applied with respect to the foreign exchange losses sustained by Holdco on the disposition, upon maturity, of commercial papers. If this is the case, such foreign exchange losses will only affect Holdco's CDA at the end of the taxation year in which the relevant dispositions occurred.
Reasons: Wording of the Act and previous positions. Request for opinion - XXXXXXXXXX - Impact of exchange rate losses on the capital dividend account.
July 23, 2007
Technical Applications and Evaluation Division Income Tax Rulings Directorate 112 Kent Street S. Prud'Homme Place de Ville, Tower B, 13th floor (613) 957-8975 Ottawa ON K1A 0L5 Attention: Mr. Marcel Querry 2007-023469
Request for opinion - XXXXXXXXXX - Impact of exchange rate losses on the capital dividend account
This is in response to your memorandum of May 2, 2007, requesting our opinion on the impact of exchange rate losses sustained by a corporation on its capital dividend account ("CDA").
For the purposes of our opinion, we have reviewed the following documents provided by you:
- Memorandum dated January 10, 2007, from XXXXXXXXXX, addressed to Ms. Grace Derfel of the Canada Revenue Agency ("CRA");
- Memorandum dated February 8, 2007, from you to Ms. Raymonde Pelletier, SME Audit, Montreal Tax Services Office;
- Letter dated February 12, 2007, from XXXXXXXXXX, addressed to Ms. Grace Derfel of the CRA;
- Letter dated April 24, 2007, from XXXXXXXXXX, addressed to you.
It should be noted that our analysis was based solely on a review of the documents you provided to us. You did not consider it relevant at this stage of the case for us to see any other documents related to the present case.
In addition, and unless otherwise specified, any statutory references herein are to provisions of the Income Tax Act (the "Act") or any of its provisions.
1) Facts and assumptions relevant to this file
To the best of our understanding, and based on the above reviewed documents, the material facts and assumptions relating to this case can be summarized as follows:
(a) XXXXXXXXXX. ("Portfolioco") is a private company as defined in subsection 89(1). Portfolioco's fiscal period ends on XXXXXXXXXX of each year.
(b) During its taxation year ending XXXXXXXXXX, Portfolioco, at various times, sustained losses as a result of the fluctuation in the value of the U.S. currency relative to the Canadian currency. Specifically, we understand that the vast majority of those foreign exchange losses resulted from Portfolioco's disposition of securities and commercial paper, as well as the issuers' discharge of commercial paper when due.
(c) On XXXXXXXXXX, Portfolioco elected to pay a capital dividend in the amount of $XXXXXXXXXX to its shareholders pursuant to subsection 83(2).
According to the taxpayer's representatives, Portfolioco's CDA balance at that time was $XXXXXXXXXX. In that regard, the taxpayer's representatives take the position that the foreign exchange losses sustained by Portfolioco between XXXXXXXXXX came within subsection 39(2). Because of the terms of that statutory provision, it is the taxpayer's representatives' position that Portfolioco's CDA would only be reduced by the foreign exchange losses sustained in the taxation year ending XXXXXXXXXX at the last time in that taxation year, and thus at a time subsequent to the time of payment of the capital dividend by Portfolioco.
(d) You are of the view that the foreign exchange losses sustained by Portfolioco between XXXXXXXXXX should have reduced Portfolioco's CDA balance on XXXXXXXXXX. As a result, Portfolioco made an election by virtue of subsection 83(2), in respect of dividends payable on shares of its capital stock, that exceeded its CDA balance on XXXXXXXXXX.
(e) We understand that Portfolioco has taken the position that at all relevant times it held the securities and commercial paper referred to above as capital property within the meaning of section 54.
2) Summary of the position of the taxpayers' representatives
According to the taxpayer's representatives, the balance in Portfolioco's CDA at the time of the payment of the capital dividend on XXXXXXXXXX was $XXXXXXXXXX and would therefore not have been affected by the foreign exchange losses sustained by Portfolioco between XXXXXXXXXX.
In that regard, and as noted above, the taxpayer's representatives take the position that the foreign exchange losses sustained by Portfolioco in the taxation year ending XXXXXXXXXX would be subject to subsection 39(2). The taxpayer's representatives are of the view that, for the purposes of determining a capital gain or loss resulting from a foreign exchange gain or loss, subsection 39(2) takes precedence over subsection 39(1). This is said to be due to the opening words of subsection 39(2) which read "Notwithstanding subsection 39(1)".
Because of the terms of subsection 39(2), the taxpayer's representatives are of the view that Portfolioco's CDA would only be reduced by the foreign exchange losses sustained in the taxation year ending XXXXXXXXXX at the last time in that taxation year, and thus at a time subsequent to the time of payment of the capital dividend by Portfolioco. In order for there to be a reduction in Portfolioco's CDA at a particular time, clause (a)(ii)(A) of the definition of CDA in subsection 89(1) requires that the corporation have a "capital loss" from the disposition of a property before the particular time. According to the taxpayer's representatives, although Portfolioco sustained "exchange losses" between XXXXXXXXXX, Portfolioco technically did not incur any "capital losses" pursuant to subsection 39(2) until the end of the taxation year ending XXXXXXXXXX. Paragraph 39(2)(b) provides that the amount by which the total of a taxpayer's foreign currency losses in a taxation year exceeds the total of the taxpayer's foreign currency gains in that taxation year is deemed to be a capital loss of the taxpayer for the year from the disposition of foreign currency. Given that Portfolioco's capital loss resulting from the application of subsection 39(2) can only be determined at the end of its taxation year ending on XXXXXXXXXX and only after considering all foreign exchange gains/losses realized/sustained during that taxation year, it is the opinion of the taxpayer's representatives that such a capital loss can only exist and therefore affect the CDA balance at the end of Portfolioco's taxation year ending on XXXXXXXXXX.
3) Summary of your position in this file
You are of the view that the foreign exchange losses sustained by Portfolioco between XXXXXXXXXX should have reduced Portfolioco's CDA balance on XXXXXXXXXX. As a result, Portfolioco made an election pursuant to subsection 83(2), in respect of dividends payable on shares of its capital stock, that exceeded its CDA balance on XXXXXXXXXX.
You are of the view that, for the purposes of calculating the CDA, it is the time of disposition of a property that is important, regardless of the treatment of the deemed capital gain (or loss) under subsection 39(2). In your view, a capital gain (or loss) resulting from the application of subsection 39(2) should have the same impact on a corporation's CDA calculation as a capital gain (or loss) resulting from the application of subsection 39(1). In your view, what matters for the purposes of calculating the CDA is not the time at which the capital gain (or loss) is included in the taxpayer's income, but the time at which the corresponding property is disposed of.
4) Your question regarding this file
You wish to know where a foreign exchange gain or loss under subsection 39(2) will affect a corporation's CDA balance. Specifically, you wish to know whether we are of the view that foreign exchange losses sustained by Portfolioco between XXXXXXXXXX should have reduced Portfolioco's CDA balance on XXXXXXXXXX.
5) Our comments on this file
In our view, in order to answer the question raised in this case, it is first necessary to determine whether the foreign exchange losses sustained by Portfolioco between XXXXXXXXXX were subject to subsection 39(1) or subsection 39(2).
We understand that the vast majority of these foreign exchange losses result from Portfolioco's disposition of securities and commercial paper, as well as the issuers' discharge of commercial paper at maturity.
In this regard, the CRA's position is that, in respect of a gain or loss on the disposition of property, subsection 39(2) will apply if, and only if, the gain or loss is solely attributable to the fluctuation in value of a foreign currency relative to Canadian currency. If the gain or loss is not solely attributable to a fluctuation in the value of a foreign currency relative to Canadian currency, subsection 39(1), and not subsection 39(2), must be used to calculate the capital gain or loss on the disposition of the property.
Subsection 39(1) provides that a taxpayer's capital gain (or loss) from any property is the gain determined under subdivision c of the Act. In summary, paragraph 40(1)(a) provides that a taxpayer's gain from the disposition of any property is the amount, if any, by which the proceeds of disposition exceed the adjusted cost base (ACB) to the taxpayer of the property. Paragraph 40(1)(b) provides that a taxpayer's loss from the disposition of any property is the amount, if any, by which the ACB to the taxpayer's of the property exceeds the proceeds of disposition of the property.
Where subsections 39(1) and 40(1) apply in respect of the disposition of a capital property that is a foreign currency security, the CRA's position is that the capital gain (or loss) must be calculated by converting the ACB and the proceeds of disposition of the security into Canadian currency using the exchange rate prevailing at the relevant time. Specifically, the CRA's position is that the ACB must be converted into Canadian currency using the exchange rate prevailing at the time the security was acquired, and the proceeds of disposition of the security must be converted into Canadian currency using the exchange rate prevailing at the time the security was disposed of. This position is based on Gaynor v. The Queen, 91 DTC 5288 (F.C.A.). Of course, under this approach, the capital gain or loss resulting from the application of subsections 39(1) and 40(1) will have been increased or reduced by fluctuations in the foreign currency relative to the Canadian currency between the time the property was acquired and the time of its disposition.
Based on the foregoing, it is our view that subsection 39(1), and not subsection 39(2), should have applied in respect of each of the dispositions of securities and commercial paper (before maturity) made by Portfolioco in its taxation year ending XXXXXXXXXX. Accordingly, the capital gain (or loss) realized by Portfolioco as a result of each such disposition of capital property (including foreign exchange gain or loss) would have affected the balance of Portfolioco's CDA at the time of the relevant disposition, not just at the end of its taxation year ending XXXXXXXXXX. In that respect, we therefore disagree with the position taken by the taxpayer's representatives in this case.
Furthermore, it would appear that subsection 39(2) should have applied in respect of the foreign exchange losses sustained on the discharge of the commercial paper by the issuers at maturity. Indeed, it is likely that the loss sustained by Portfolioco on the redemption of the commercial paper was solely attributable to the fluctuation in the value of the US currency against the Canadian currency. Although we do not have detailed information with respect to such commercial paper, it is our understanding that where such securities are held to maturity, the taxpayer generally does not realize a capital gain (loss) related to the intrinsic value of the security. However, various legislative provisions of the Act generally require the taxpayer to include the return on the security in income at various times between the acquisition of the security and its disposition at maturity.
To the extent that subsection 39(2) is applicable in respect of foreign exchange losses sustained by Portfolioco on the discharge, at maturity, of the commercial paper by the Issuers in its taxation year ending XXXXXXXXXX, it is our view that such foreign exchange losses will only have affected Portfolioco's CDA balance at the end of its taxation year ending XXXXXXXXXX. In other words, Portfolioco's CDA balance at the time of the capital dividend payment on XXXXXXXXXX would not have been reduced by the foreign exchange losses sustained by Portfolioco on the discharge, at maturity, of the commercial paper by the issuers between XXXXXXXXXX. In that regard, we agree with the position of the taxpayer's representatives, solely with respect to the timing of the inclusion of a subsection 39(2) foreign exchange gain (or loss) for the purposes of computing a corporation's CDA.
6) Conclusion
It is our view that subsection 39(1), and not subsection 39(2), should have applied in respect of each of the dispositions of securities and commercial paper (before maturity) made by Portfolioco in its taxation year ending XXXXXXXXXX. As a result, the capital gain (or loss) realized by Portfolioco as a result of each such disposition of capital property (including foreign exchange gain or loss) would have affected the balance of Portfolioco's CDA at the time of the relevant disposition, not just at the end of its taxation year ending XXXXXXXXXX.
Furthermore, it would appear that subsection 39(2) should have applied in respect of the foreign exchange losses sustained on the discharge of the commercial paper by the issuers at maturity. Indeed, it is likely that on the discharge of such commercial paper, the loss sustained by Portfolioco will have been solely attributable to the fluctuation in the value of the US currency against the Canadian currency. To the extent that subsection 39(2) is applicable in respect of foreign exchange losses sustained by Portfolioco on the discharge, at maturity, of the commercial paper by the Issuers in its taxation year ending XXXXXXXXXX, we are of the view that such foreign exchange losses will only have affected Portfolioco's CDA balance at the end of its taxation year ending XXXXXXXXXX.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Should you require further information on this subject, please do not hesitate to contact us.
Stéphane Prud'Homme, Notary, M.Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.