Canco, which was a wholly-owned subsidiary of a US-resident public-company parent (Parent), borrowed in a foreign currency from Sisterco (a non-resident wholly-owned subsidiary of Parent) in order for it to pay a dividend to Parent. In order to hedge its currency risk under the loan from Sisterco, Canco entered into cross-currency swap agreements with Canadian banks, involving an exchange of periodic notional interest payments, and a notional exchange of principal amounts on maturity, in the two currencies.
CRA stated:
...the gain or loss computed in reference to the settlement of a hedge is characterized for tax purposes depending upon the transaction being hedged. Therefore, in this case, since we have a loan to Sisterco as the underlying transaction, the loan would be considered on capital account since it was for the purpose of paying a dividend. In our view, the gain or loss realized on the settlement of the hedge would also be on capital account.