Principal Issues: 1. Application of loss denial rules to a foreign exchange loss realized on the payment of a loan owing to an affiliated person.
2. Application of loss denial rules to a foreign exchange loss realized on the payment of a loan owing to an affiliated person where that loan is replaced by another loan from the affiliated person with different terms and conditions.
Position: 1. Subparagraph 40(2)(g)(i) and paragraphs 40(3.3) and (3.4) do not apply.
2. Subparagraph 40(2)(g)(i) and paragraphs 40(3.3) and (3.4) do not apply.
Reasons: 1. Previous position. Loss arises by virtue of the payment of the loan since the loss does not arise from the disposition of a particular property by the debtor that is, or is identical to, property acquired by the creditor. The loan is a liability of the debtor and, as such is not property of the debtor. Consequently, the repayment of the loan does not, in itself, result in a disposition of property by the debtor. In addition, although subsection 39(2) deems the loss realized on the payment of the loan to be a capital loss from the disposition of a currency of a country other than Canada, this provision does not deem the creditor to acquire the foreign currency deemed to be disposed under this provision.
2. In such a situation, a debtor would receive foreign cash by way of a new loan owed to the same affiliated person. The question is whether such foreign cash would be identical property to the cash the debtor is deemed to have disposed of pursuant to subsection 39(2). For the purposes of subparagraph 40(2)(g)(i) and paragraphs 40(3.3) and (3.4) when determining whether the debtor has acquired an identical property when the new foreign cash is received by virtue of the new loan, we have taken the position that such foreign cash would not be an identical property in similar circumstances where a taxpayer has sustained a loss under subsection 39(2).
Financial Strategies and Financial Instruments Roundtable--2017 APFF
Question 10
Foreign exchange losses and superficial losses
Where a borrower affiliated with a trust borrows at a market rate in US dollars from the trust, the repayment of the debt will result in a foreign exchange loss for that borrower if the value of the US dollar against the Canadian dollar has appreciated over the term of the loan.
The lending trust also realizes an equivalent foreign exchange gain on the repayment of the loan receivable, which is an asset. US currency is paid by the borrower to the lending trust, which may or may not hold such proceeds in the same currency, or convert or reinvest them. The loan receivable disappears from the balance sheet of the trust as an asset as soon as it is repaid and converted into cash or reinvested.
The definition of a superficial loss in section 54 provides the following conditions:
(a) during the period that begins 30 days before and ends 30 days after the disposition, the taxpayer or a person affiliated with the taxpayer acquires a property (in this definition referred to as the “substituted property”) that is, or is identical to, the particular property, and
(b) at the end of that period, the taxpayer or a person affiliated with the taxpayer owns or had a right to acquire the substituted property,
Questions to the CRA:
(a) Since the debt is repaid when the foreign exchange loss is realized, the debt is no longer on the lender's balance sheet on the 30th day assuming no additional debt is incurred during the 30 days before or after repayment of the loan. Can you confirm that the foreign exchange loss realized on debt repayment from an affiliated person cannot qualify as a superficial loss?
b) If the trust made a new loan in US currency to the same borrower during the 30-day period preceding or following the repayment, and the new loan was still in effect on the 30th day following repayment
(i) would the loan qualify as "identical property" if the terms were different (amounts, term, maturity and rate)?
(ii) would the loss qualify as a superficial loss if the terms were different (amounts, term, maturity and rate)?
CRA response to Question 10(a)
Paragraph 40(2)(g) applies, inter alia, to deem a loss of a taxpayer from the disposition of property that is a superficial loss, as defined in section 54, to be nil.
A superficial loss does not include loss from a disposition that is subject to subsection 40(3.4). However, subsections 40(3.3) and 40(3.4) also provide a similar rule for deeming a loss on the disposition of property to be nil.
Subparagraph 40(2)(g)(i) and subsections 40(3.3) and 40(3.4) would not apply to a capital loss realized by a borrower on the repayment of its loan since the loss would not result from the disposition of property that would be acquired by the affiliated creditor or the borrower or that would have been replaced by an identical property acquired by the affiliated creditor or the borrower. In particular, the borrowing would be one of the borrower's liabilities and, as such, would not be property of the borrower. Consequently, repayment of the loan by the borrower would not, in itself, constitute the disposition of a property by the borrower. Furthermore, although subsection 39(2) deems there to be a capital loss arising from the disposition of a currency other than Canadian currency, subsection 39(2) does not deem the affiliated creditor to have acquired the foreign currency which the borrower is deemed to have disposed of.
CRA response to Question 10(b)
For subsection 39(2) to apply, it must first be determined whether a gain has been realized or whether the taxpayer has sustained a loss. For example, if there was an exchange of debts without their repayment or novation, there could be no event engaging the application of subsection 39(2).
On the other hand, the repayment of the principal amount of a loan by the debtor or the novation of such debt would be events giving rise to a gain or loss in accordance with subsection 39(2).
In this regard, the new loan would not represent, to the borrower, an identical property to the original loan since the new loan would be a liability and not a property.
Furthermore, the borrower would have received foreign currency by virtue of the new loan made to it. The issue is whether, for the purposes of subparagraph 40(2)(g)(i) or subsections 40(3.3) and (3.4), that foreign currency would be identical property to the currency that the borrower is deemed to have disposed of in accordance with subsection 39(2). According to the definition of "property" in subsection 248(1), money could constitute property unless a contrary intention is evident. However, the CRA's position is not to consider money to be identical property for the purposes of subparagraph 40(2)(g)(i) or subsections 40(3.3) and (3.4) in a circumstance such as this where a taxpayer sustains a loss under subsection 39(2).
Sylvie Labarre
October 6, 2017
2017-070520