Canco, which for all relevant years has filed its returns in U.S. dollars as its functional currency pursuant to an election made under s. 261(3), becomes entitled to a Canadian dollar refund as a result of filing an amended return for an earlier such year (2012). The amount thereof, if it were converted to USD using the exchange rate as of the date of the refund, is greater than the USD amount that would be determined by converting the overpayment to USD using the exchange rate(s) that were initially used in determining Canco’s income tax payable for its 2012 taxation year.
Does such FX fluctuation give rise to a gain that will be included in Canco’s income? CRA indicated that as to where a taxpayer who is not a functional currency reporter pays taxes in another jurisdiction in a foreign currency, and receives a refund, Folio S5-F2-C1 states:
...any difference between this figure and the Canadian dollar value of a refund of the overpayment, computed as of the day of its receipt, will be a gain or loss on exchange to which the rules in subsections 39(1) to (2.1) will apply.
Here, Canco, as a functional currency reporter would be subject to s. 261(5)(a), which provides for its computing its Canadian tax results in the elected currency. When determining the amount of the payment, it must then convert to Canadian dollars, as per s. 261(11).
A functional currency reporter’s foreign-exchange risk arising from an overpayment of Canadian income tax is comparable to a Canadian resident’s foreign-exchange risk arising from the overpayment of tax to a foreign jurisdiction. S. 39 would apply to the gain or loss. Therefore, s. 39 would apply to the foreign-exchange gain or loss that a functional currency reporter might realize.