Principal Issues: (1) Whether a corporation may claim a terminal loss or capital loss when it transfers depreciable property, capital property and intangible property from a Branch operation in Canada to its Head Office in the US. (2) Whether the deferral on an unrealized foreign exchange gain is permitted on a "loan" from the corporate Head Office to the Canadian branch operation in the situation where the branch is winding down.
Position: (1) There is a deemed disposition for purposes of the Act. The branch should record the disposition of the equipment at its fair market value (FMV) at the time the equipment is moved to the US Head Office expressed in Canadian dollars. (2) The "loan" between the US Head Office and the branch is not considered to be a debt obligation. Since a loan does not exist, there can be no foreign exchange implications for income tax purposes in respect of the "loan" from the US Head Office.
Reasons: (1) Paragraph 13(7)(a) deems depreciable property to be disposed of and reacquired at fair market value at the time there is a change in the purpose of its use from gaining or producing income to some other purpose. (2) The branch is not considered to be a separate legal person from the US Head Office (they are the same person). There is no debt obligation; therefore, section 76.1 would not be applicable.
September 16, 2011
XXXXXXXXXX Lita Krantz Assistant Director XXXXXXXXXX Tax Services Office International & Trusts Division Income Tax Rulings Directorate
2010 – 038357
Transfer of Property from a Canadian Branch to a US Head Office
Further to your request and subsequent communications with the auditor relating to the above subject we are providing our comments on the two issues identified below. We apologise for our delay.
ISSUES
1) Whether a corporation may claim a terminal loss or capital loss when it transfers depreciable property, capital property and intangible property from a Branch operation in Canada to its Head Office in the U.S. Ancillary to this issue is whether the proceeds of disposition may be based on US$ net book value (NBV) rather than CDN$ NBV.
2) Whether the deferral on an unrealized foreign exchange gain is permitted on a "loan" from the corporate U.S. Head office to the Canadian Branch operation in the situation where the Branch operations were winding down.
FACTS
The following facts were provided:
a) A Canadian Branch ("Branch") of a US corporation acquired certain machinery and equipment ("equipment") in the 2002 and subsequent taxation years.
b) The cost of the equipment was recorded in the accounting records of the Branch operation in CDN$ and in US$ in the US corporation's accounting records.
c) In 2007 the equipment, along with other capital and intangible assets ("assets"), were transferred to the US Head Office due to the winding down of the Branch.
d) The Branch remained in existence in 2007 and subsequent taxation years (not known how long) for the purposes of leasing certain property.
e) The transfer of the equipment was recorded in the accounting records as a disposition by the Branch for proceeds equal to NBV.
f) Significant foreign exchange losses were reported for some of the asset transfers.
g) A loan in US$ was given by the US Head Office to the Branch for the acquisition of Goodwill and Inventory. Interest is fixed at 6.93% and the repayment of the loan will be in US$. There is no term stipulating the time of repayment.
h) The Branch revalues the loan into its CDN$ equivalent at the end of each fiscal year.
i) The foreign exchange gain/loss is credited/debited to a foreign exchange reserve account on the balance sheet. The taxpayer does not report the gain/loss for tax purposes.
j) The International Tax Services Office was also consulted for an opinion on the ancillary issue noted under issue one above.
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OUR COMMENTS
Issue One
We have considered only the impacts of the legislation on the transfer of the equipment and not the other assets since based on our communications with the auditor this seems to be the focus of her concern.
Paragraph 13(7)(a) deems depreciable property to be disposed of and reacquired at FMV at the time there is a change in the purpose of its use from gaining or producing income to some other purpose. Where the taxpayer is a non-resident, paragraph 13(7)(a) is modified by subsection 13(9). The modification provides that where depreciable property is acquired for the purpose of gaining or producing income from a business wholly carried on in Canada or such part of a business as is wholly carried on Canada and this purpose is changed to some other purpose (e.g. gaining or producing income from a business carried on outside of Canada), the change will trigger the deemed disposition and reacquisition of the property at FMV. The movement of property across the border is enough to invoke the application of subsection 13(7). This is consistent with CRA's positions stated in E2010-0359261E5, XXXXXXXXXX and E9624996. The deemed disposition may result in either recapture under subsection 13(1) or a terminal loss under subsection 20(16).
Determining whether there is recapture or a terminal loss is dependent in part on the proceeds of disposition and whether other property remains in the relevant capital cost allowance class. Since the property is deemed to have been disposed of at FMV, the "proceeds of disposition" for purposes of clause F of the definition of undepreciated capital cost under subsection 13(21) will be FMV (up to the limit of historical cost for purposes of F). The Branch is using NBV as the proceeds of disposition. If NBV equates FMV then this is the appropriate value to use. It will be up to the auditor to determine if the NBV is an acceptable estimate of the FMV. The proceeds of disposition at the time the property is moved is to be expressed in Canadian dollars using the rate of exchange prevailing at that time.
Issue Two
Subsection 76.1 provides the rules where a debt of a non-resident taxpayer, denominated in a foreign currency, ceases to be an obligation of the taxpayer in respect of the CDN business. Since the Branch is not a separate legal person from the US Head Office (they are the same person), the "loan" between the Branch and the US Head Office is not considered to be a debt obligation. The Branch advance is merely an allocation from the US Head Office to the Branch. Since there is no debt, section 76.1 would not be applicable.
In addition, since there is no debt, the foreign exchange "gain" or "loss" recorded on the Branch's balance sheet is considered a paper transaction which is not recognized for tax purposes.
CONCLUSION
There is a deemed disposition for purposes of the Act. The Branch should record the disposition of the equipment at its FMV at the time the equipment is moved to the US Head Office expressed in Canadian dollars. Whether or not the NBV is equivalent to the FMV is a question of fact which will need to be determined by the auditor. As a result of the disposition, recapture or a terminal loss may arise under subsection 13(1) and subsection 20(16), respectively.
Since a loan does not exist there can be no foreign exchange implications for income tax purposes in respect of the "loan" from Head Office.
We trust the above satisfies your request.
Lita Krantz
Assistant Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate