Principal Issues: A parent corporation ("Parentco") owns preferred shares of the capital stock of a subsidiary wholly-owned corporation ("Subco") denominated in U.S. dollars (the "U.S. Preferred Shares"). Subco purchases for cancellation the U.S. Preferred Shares. In consideration, it issues to Parentco preferred shares of another class denominated in Canadian dollars (the "Canadian Preferred Shares"). The purchase price, in Canadian dollars, of the U.S. Preferred Shares and the stated capital, in Canadian dollars of the Canadian Preferred Shares are higher than the value, in Canadian dollars, of the U.S. Preferred Shares at the time of their issuance. Subsection 86(1) of the Act applies with respect to the disposition of the U.S. Preferred Shares by Parentco. Whether Subco has sustained a loss pursuant to subsection 39(2) of the Act by reason of the purchase for cancellation of the U.S. Preferred Shares and the issuance of the Canadian Preferred Shares.
Position: There is a good argument that Subco has not sustained a loss pursuant to subsection 39(2) of the Act by reason of the purchase for cancellation of the U.S. Preferred Shares and the issuance of the Canadian Preferred Shares.
Reasons: The patrimony of Subco remained unaffected by the transaction since Subco did not transfer any property (money or other) it owned at that time to Parentco in payment of the U.S. Preferred Shares. The only effect of the transaction was merely to change the claims of various classes of shareholders on Subco's assets. In this situation, even this effect of the transaction is theoretical considering that Subco is a subsidiary wholly-owned corporation. The decision of the Federal Court of Appeal in MacMillan Bloedel Ltd. can be distinguished from the situation in this file because, in MacMillan Bloedel, the taxpayer redeemed its preferred shares by paying a cash amount to the shareholders. This had a clear impact on the taxpayer's patrimony.
July 23, 2007
Montreal Tax Services Office Income Tax Rulings Directorate 1208 Section 441-1-1, 7th floor S. Prud'Homme (613) 957-8975 Attention: Mr. Jean Rousseau 2007-022860
Request for Opinion - XXXXXXXXXX - Redemption of Preferred Shares of XXXXXXXXXX - Application of subsection 39(2) of the Income Tax Act
This is in response to your memorandum of March 19, 2007, in which you requested our opinion regarding the potential application of subsection 39(2) of the Income Tax Act (the "Act") regarding the above file.
For the purposes of our opinion, we have reviewed the following documents provided by you:
- copy of information request form T997 dated January 27, 2005, from Ms. Loan Nguyen, auditor of the Canada Revenue Agency ("CRA") and concerning XXXXXXXXXX and its corporate affiliates;
- email dated April 13, 2006, from you to XXXXXXXXXX with a proposed reassessment for the XXXXXXXXXX taxation year of XXXXXXXXXX;
- response dated May 10, 2006, to the above-mentioned proposed reassessment from XXXXXXXXXX;
- memo dated December 6, 2006, from Mr. Ubaldo De Felice, Case Manager, Major Files, Montreal Tax Services Office, addressed to XXXXXXXXXX;
- response to the CRA memo of December 6, 2006, from XXXXXXXXXX Group;
- letter dated February 23, 2007, from XXXXXXXXXX, addressed to Mr. Ubaldo De Felice of the CRA;
- Draft memo of March 6, 2007, from you to the Technical Applications and Valuation Division, Corporate Income Tax Section;
- letter of March 16, 2007, from XXXXXXXXXX, addressed to Mr. Ubaldo De Felice of the CRA;
- memorandum dated March 19, 2007, from you to the Corporate Reorganization and Resource Industry Division, Income Tax Rulings Directorate, to the attention of Mr. Maurice Bisson, Manager.
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 file for us to see any other documents relating to it.
In addition, and unless otherwise specified, any statutory reference herein is to a provision of the Act.
(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 ("Parentco") XXXXXXXXXX
(b) XXXXXXXXXX ("ForeignSubsidiary") was incorporated under the authority of XXXXXXXXXX. The incorporation of ForeignSubsidiary was effected in connection with the establishment by Parentco of a U.S. real estate investment trust (or "REIT").
Parentco held all of the issued and outstanding (voting) common shares of the capital stock of ForeignSubsidiary. To finance its operations, ForeignSubsidiary also issued non-voting exchangeable preferred shares to the public.
(c) Parentco incorporated XXXXXXXXXX ("Holdco") pursuant to the Canada Business Corporations Act on August 26, 1999.
Parentco held all of the issued and outstanding (voting) common shares in the capital stock of Holdco.
We understand that at all relevant times between XXXXXXXXXX (the date of incorporation of Holdco) and XXXXXXXXXX (the date of the purchase for cancellation of shares described in (1)(n) below), Holdco was a XXXXXXXXXX per cent subsidiary of Parentco.
Holdco was formed because Parentco wished to consolidate some of its non-financial institution subsidiaries under a single holding company.
(d) On XXXXXXXXXX, Parentco disposed of all of the issued and outstanding (voting) common shares in the capital stock of ForeignSubsidiary to Holdco for consideration equal to the fair market value of such transferred common shares, being approximately U.S.$XXXXXXXXXX (approximately Cdn.$XXXXXXXXXX, taking into account that, at that time, U.S.$1 was equivalent to Cdn.$1.4745). In consideration for the assets transferred to Holdco, Parentco received XXXXXXXXXX preferred shares of XXXXXXXXXX, without par value, in the capital stock of Holdco. The redemption value of those XXXXXXXXXX preferred shares was set at approximately U.S.$XXXXXXXXXX, being the value of the consideration received for the issuance of such preferred shares. In addition, approximately U.S.$XXXXXXXXXX was added to the stated capital account of the XXXXXXXXXX preferred shares in the capital stock of Holdco.
The share transfer described above was made on a tax-free basis pursuant to subsection 85(1). The agreed amount determined by Parentco and Holdco in respect of the transferred common shares of the capital stock of ForeignSubsidiary was approximately Cdn.$XXXXXXXXXX. The paid-up capital of the XXXXXXXXXX preferred shares in the capital stock of Holdco was determined pursuant to the provisions of subsection 85(2.1).
e) The XXXXXXXXXX preferred shares in the capital stock of Holdco were non-voting and non-participating, and entitled to receive fixed, non-cumulative, preferential dividends at a rate of XXXXXXXXXX%, calculated on the redemption price. Those XXXXXXXXXX preferred shares were also redeemable at the option of the company or the holder for a price equal to the fair market value of the consideration received at the time of issuance (being U.S.$XXXXXXXXXX in this case, being the fair market value of the common shares of the capital stock of ForeignSubsidiary transferred from Parentco to Holdco on XXXXXXXXXX), plus an amount equal to declared and unpaid dividends. Upon the winding up of the corporation, the XXXXXXXXXX preferred shares were entitled, in priority to the holders of shares of other classes ranking after the XXXXXXXXXX preferred shares, and pari passu with the holders of XXXXXXXXXX preferred shares of other series, to payment of the redemption amount of such shares, plus an amount equal to declared and unpaid dividends.
f) In accordance with Parentco's wish to consolidate certain of its non-financial institution subsidiaries under one holding corporation, we understand that Parentco transferred ownership of at least XXXXXXXXXX other subsidiaries to Holdco between XXXXXXXXXX.
(g) Representatives of Parentco noted that, during the XXXXXXXXXX, year the transfer by Parentco to Holdco of its investment in Foreign Subsidiary, as described in (1)(d) above, was contrary to an order issued by XXXXXXXXXX. That order authorized the acquisition by Parentco, by way of a temporary investment, of more than XXXXXXXXXX% of the voting shares of ForeignSubsidiary, provided, however, that Parentco held directly all of the voting shares of ForeignSubsidiary at all times.
In order to regularize the situation, Parentco caused Holdco to "retrocede" to it, as of XXXXXXXXXX, all of the shares of the capital stock of ForeignSubsidiary that had been acquired on XXXXXXXXXX. This retrocession of the investment in ForeignSubsidiary was effected in the manner described in (1)(h) to (1)(l) below.
In connection with the foregoing, we assume that even though some of the transactions described herein may have been contrary to provisions of the XXXXXXXXXX, each of the transactions described in (1) was still legally valid.
h) Parentco incorporated XXXXXXXXXX ("Sisterco") pursuant to the Canada Business Corporations Act on XXXXXXXXXX. Parentco then subscribed for XXXXXXXXXX common shares in the capital stock of Sisterco.
i) On XXXXXXXXXX, Holdco amended its articles to create, inter alia, an unlimited number of XXXXXXXXXX preferred shares, without par value. Those XXXXXXXXXX preferred shares have the same rights, privileges, conditions and restrictions as the XXXXXXXXXX preferred shares, except for a slight difference in the redemption notice period (XXXXXXXXXX). The XXXXXXXXXX Preferred Shares in the capital stock of Holdco were created so that the value of the issued shares of this series would be denominated in Canadian dollars.
(j) On XXXXXXXXXX, Holdco disposed of all of the issued and outstanding (voting) common shares in the capital stock of ForeignSubsidiary to Sisterco for consideration equal to the fair market value of the common shares transferred, being approximately U.S.$XXXXXXXXXX (approximately Cdn.$XXXXXXXXXX, taking into account that at that time U.S.$1 was equivalent to Cdn.$1.5887). In consideration for the assets transferred to Sisterco, Holdco received XXXXXXXXXX preferred shares in the capital stock of Sisterco. The redemption value of those preference shares was set at approximately U.S.$XXXXXXXXXX, being the value of the consideration received for the issuance of such preferred shares.
The transfer of shares described above was made on a tax-free basis pursuant to subsection 85(1). The paid-up capital of the preferred shares in the capital stock of Sisterco was determined pursuant to the provisions of subsection 85(2.1).
The taxpayers' representatives appear to have taken the position that on the disposition of the interest in ForeignSubsidiary described above, Holdco did not realize any exchange rate gain. In that regard, the CRA's long-standing position is that where there is a disposition of capital property and that disposition does not result in a gain or loss for purposes of section 40, there is also no gain or loss for purposes of subsections 39(1) and 39(2).
k) On XXXXXXXXXX and after the share transfer described in the previous paragraph, Sisterco redeemed the preferred shares of its capital stock owned by Holdco. In return, Sisterco issued to Holdco subordinated debt payable on demand equal in value to the redemption value of the preferred shares, being approximately Cdn.$XXXXXXXXXX. We understand that Holdco has accepted this subordinated debt as full and absolute payment for the redemption of the preferred shares in the capital stock of Sisterco.
For tax purposes, on the redemption of those preferred shares, Sisterco was deemed to have paid and Holdco was deemed to have received a dividend pursuant to subsection 84(3), in respect of the redemption of those preferred shares, equal to the amount by which the redemption value of the preferred shares exceeded the paid-up capital of the subject shares.
We understand that Holdco deducted this deemed dividend in computing its taxable income pursuant to subsection 112(1) and considered that subsection 112(2.1) did not apply.
We also understand that Holdco took the position that the above deemed dividend did not give rise to the application of subsection 55(2) because of the application of paragraph 55(3)(a). In this regard, we refer you to an April 21, 2005, "comfort letter" from the Department of Finance to the effect that the winding-up of a subsidiary in a public corporation of the type described in (1)(l) below technically resulted in significant increases in direct holdings in the wound-up corporation by the shareholders of the public corporation referred to in paragraphs 55(3)(a)(ii) and (v). The Department of Finance indicated in the "comfort letter" of April 21, 2005, that this result was not desirable and that it intended to recommend to the Minister that the Act be amended to address this technical problem. We understand that the Department of Finance has recommended that those proposed amendments be applicable in respect of dividends received after 2004.
It appears that a portion of the amount of the deemed dividend deducted by Holdco and referred to above was related to a foreign exchange gain, resulting from Holdco's holding of the investment in ForeignSubsidiary between XXXXXXXXXX and the appreciation of the U.S. dollar against the Canadian dollar during the same period.
(l) On XXXXXXXXXX, following the share redemption described in the preceding paragraph, Sisterco was wound up into Parentco. As part of that winding-up, Parentco received all of the property owned by Sisterco at the time of its winding-up (including the issued and outstanding (voting) common shares of the capital stock of ForeignSubsidiary) and assumed all of the debts and obligations of Sisterco (including the subordinated debt owed to Holdco). Section 88(1) applied to the winding-up of Sisterco into Parentco.
m) Immediately after those transactions, Parentco still held XXXXXXXXXX preferred shares of XXXXXXXXXX, of the capital stock of Holdco whose stated capital and redemption value, for corporate law purposes, were denominated in U.S. dollars.
n) On XXXXXXXXXX, following the winding-up of Sisterco into Parentco described in (1)(l) above, Holdco purchased for cancellation the XXXXXXXXXX preferred shares of XXXXXXXXXX, of its capital stock held by Parentco. The purchase price for the XXXXXXXXXX preferred shares in the capital stock of Holdco was the fair market value of the shares at the time of the transaction, which was approximately Cdn.$XXXXXXXXXX (approximately U.S.$XXXXXXXXXX, taking into account that at that time U.S.$1 was equivalent to Cdn.$ 1.5887). In return, Holdco issued to Parentco preferred shares of XXXXXXXXXX, without par value, in the capital stock of Holdco. The redemption value of those XXXXXXXXXX preferred shares was set at approximately Cdn.$XXXXXXXXXX, being the value of the consideration received for the issuance of such preferred shares. In addition, approximately Cdn.$XXXXXXXXXX was added to the stated capital account of the XXXXXXXXXX preferred shares in the capital stock of Holdco.
The disposition of shares described above was effected on a tax-free basis to Parentco pursuant to subsection 86(1). The paid-up capital of the XXXXXXXXXX preferred shares in the capital stock of Holdco was determined pursuant to the provisions of subsection 86(2.1). This purchase of shares for cancellation did not result in a deemed dividend pursuant to subsection 84(3) due in part to the provisions of subsection 84(5).
(o) The representatives of the taxpayer claim that as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Canadian dollar denominated XXXXXXXXXX preferred shares, Holdco incurred an exchange rate loss of approximately Cdn.$XXXXXXX in its XXXXXXXXXX taxation year, and that under paragraph 39(2)(b), this foreign exchange loss is deemed to be a capital loss of Holdco for the XXXXXXXXXX taxation year, resulting from the disposition of foreign currency. We understand that, pursuant to paragraph 111(1)(b), Holdco carried forward approximately Csn.$XXXXXXXXXX as a net capital loss from the XXXXXXXXXX taxation year to other taxation years.
The amount of the loss of approximately $XXXXXXXXXX is calculated by the taxpayers' representatives as follows:
|
Issue value of the preferred shares of XXXXXXXXXX, |
Cdn. $XXXXXXXXXX |
|
Redemption amount of the preferred shares of XXXXXXXXXX, |
(Cdn.$XXXXXXXXXX) |
|
Foreign exchange loss |
(Cdn.$XXXXXXXXXX) |
In addition, the taxpayers' representatives take the position that the no stop-loss rule in the Act applied to the foreign exchange loss allegedly incurred by Holdco in the XXXXXXXXXX taxation year.
p) The taxpayers' representatives also take the position that on the disposition of the preferred shares of XXXXXXXXXX, described above, Parentco did not realize any exchange rate gain. In that regard, the taxpayers' representatives refer to the CRA's long-standing position that where there is a disposition of capital property and that disposition does not result in a gain or loss for purposes of section 40, there is also no gain or loss for purposes of subsections 39(1) and 39(2). In other words, that CRA position allows a taxpayer who disposes of capital property on a tax-free basis under any "rollover" provision of the Act to defer not only the gain attributable to the intrinsic value of the capital property, but also any foreign exchange gain in respect of that property. It should be noted that the CRA considers that The Queen v. MacMillan Bloedel Limited, 99 DTC 5454 (F.C.A.) does not interfere with that position. With respect to the above, see in particular the following documents: pages 36:15 and 16 of the Canadian Tax Foundation's Conference Report 2000 (E 2000-EM20425) and F 2002-0135307).
q) By way of additional information, we understand that Holdco purchased for cancellation, on XXXXXXXXXX, the XXXXXXXXXX preferred shares of XXXXXXXXXX, held by Parentco. In return, Holdco issued to Parentco XXXXXXXXXX preferred shares, XXXXXXXXXX preferred shares, and XXXXXXXXXX preferred shares, with an aggregate redemption value of approximately $XXXXXXXXXX.
We understand that the above transaction was carried out on a tax-free basis to Parentco pursuant to subsection 51(1) or subsection 86(1). The paid-up capital of the preferred shares of the capital stock of Holdco issued in that transaction was been determined in accordance with the provisions of subsection 51(3) or subsection 86(2.1).
2) Summary of the position of the taxpayers' representatives
As noted in (1)(o) above, the taxpayer representatives claim that as a result of the purchase for cancellation of the XXXXXXXXXX U.S. dollar preferred shares and the issuance of the XXXXXXXXXX Canadian dollar preferred shares, Holdco incurred an exchange rate loss of approximately Cdn.$XXXXXXXXXX in its XXXXXXXXXX taxation year, and that pursuant to paragraph 39(2)(b), this foreign exchange loss is deemed to be a capital loss of Holdco for the XXXXXXXXXX taxation year resulting from the disposition of foreign currency.
The taxpayers' representatives refer, inter alia, to The Queen v. MacMillan Bloedel Limited, 99 DTC 5454 (F.C.A.) to support their claims. In that case, the taxpayer had issued in 1977, 1982 and 1983 preferred shares denominated and redeemable in U.S. dollars. During its 1987 taxation year, the taxpayer redeemed those preferred shares by paying their holders cash consideration in U.S. dollars. The Federal Court of Appeal concluded that the excess paid by the taxpayer on redemption of the shares, as a result of an increase in the value of the U.S. dollar relative to the Canadian currency, constituted a capital loss under subsection 39(2). Strayer J. of the Federal Court of Appeal stated:
According to the plain wording of subsection 39(2) the taxpayer is only required to have sustained a loss by virtue of a currency fluctuation in order to claim a capital loss, if the amount is not otherwise included in computing income. In this case, there is no dispute with respect to the effect of the currency fluctuation; the only question is whether the share redemption payment here falls within the meaning of "loss". According to the common understanding of "loss", the respondent's payment to the shareholders clearly qualifies. That is, in Canadian dollar terms the respondent paid more to redeem the shares than it had initially received. The circumstances here are not unlike those in Tahsis Company Ltd. v. The Queen, wherein the Federal Court Trial Division interpreted subsection 39(2) as providing relief to a debtor with respect to payments owed on a loan. There, currency fluctuations forced the taxpayer to pay more Canadian dollars in order to meet his U.S. dollar loan payments. Both that taxpayer and the respondent here sustained what would ordinarily be understood to be a loss. There is nothing in subsection 39(2) to limit the meaning of "loss" such that it would not cover this otherwise straightforward result.
The taxpayers' representatives point out that, as a matter of law, Holdco purchased for cancellation the preferred shares of XXXXXXXXXX, and that there was a payment of the purchase price for those shares. The taxpayers' representatives argue that neither subsection 39(2) nor the MacMillan Bloedel decision requires payment to be in the form of cash.
The taxpayers' representatives point out that the purchase for cancellation of the XXXXXXXXXX preferred shares, denominated in U.S. dollars, and the issuance, in return, of the XXXXXXXXXX preferred shares, denominated in Canadian dollars, made it possible to crystallize the redemption value of the shares of the latter series in Canadian dollars. This allowed Holdco to avoid, from the date of purchase of the XXXXXXXXXX preferred shares and for the future, any risk related to fluctuations in the value of the U.S. currency against the Canadian currency.
The taxpayers' representatives claim that as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Canadian dollar denominated XXXXXXXXXX preferred shares in return, Holdco sustained a final and irrevocable loss in its XXXXXXXXXX taxation year. According to the taxpayers' representatives, Holdco paid more, in Canadian currency, to purchase the XXXXXXXXXX preferred shares it issued than it received when they were issued. The taxpayer representatives argue that this is the only test imposed by the Federal Court of Appeal in the MacMillan Bloedel decision. Finally, according to the taxpayer representatives, a payment of the type made by Holdco in consideration for the purchase for cancellation of the XXXXXXXXXX preferred shares, whether made in property or in cash, confirmed a loss within the meaning of subsection 39(2).
3) Summary of your position in this file
You are of the opinion that Holdco did not incur an exchange rate loss of approximately Cdn.$XXXXXXXXX within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Cdn.$XXXXXXXXXX preferred shares.
Indeed, it is your opinion, inter alia, that the payment of the purchase price through the issuance by Holdco of XXXXXXXXXX preferred shares of its capital stock, instead of cash or other property held by Holdco, did not result in Holdco actually incurring an exchange rate loss within the meaning of subsection 39(2) in its XXXXXXXXXX taxation year.
In that respect, you are of the opinion that the facts of the MacMillan Bloedel decision must be distinguished from the situation in the current file. In the MacMillan Bloedel decision, the taxpayer had redeemed those preferred shares by paying their holders cash consideration in U.S. dollars, which is not the case for Holdco in this file.
You also point out that the position advocated by the taxpayers' representatives in this case has the effect of allowing Parentco's subsidiary, Holdco, to claim a capital loss in the XXXXXXXXXX taxation year, without Parentco realizing a corresponding gain in that same year. There is therefore a disparity in that respect. It should be noted that this disparity could be described as permanent, insofar as the XXXXXXXXXX shares (or the shares substituted for them) were never redeemed on a taxable basis for Parentco. You also point out that the loss allegedly suffered by Holdco resulted from transactions between affiliated persons. Finally, it should be noted that the redemption of the shares of the capital stock of Sisterco has the effect of transforming, no more and no less, Holdco's foreign exchange gain resulting from the holding of its investment in ForeignSubsidiary between XXXXXXXXXX into a deemed dividend, which was deducted by Holdco in calculating its taxable income. That foreign exchange gain therefore did not result in any "negative" tax consequences at the Holdco level. These various elements seem to you to be problematic from a tax policy point of view.
4) Your question regarding this case
You wish to know whether, in our opinion, Holdco has actually incurred an exchange rate loss of approximately Cdn.$XXXXXXXXXX within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Cdn.$XXXXXXXXXX preferred shares on XXXXXXXXXX.
5) Our comments on this file
The preamble to subsection 39(2) and paragraph 39(2)(b) provide that where, by virtue of any fluctuation after 1971 in the value of the currency or currencies of one or more countries other than Canada relative to Canadian currency, a taxpayer has sustained a loss in a taxation year, that loss is deemed to be a capital loss of the taxpayer for the year from the disposition of the currency of a country other than Canada.
It appears from the foregoing that the fundamental issue in this case is whether Holdco actually incurred a loss in its XXXXXXXXXX taxation year as a result of the purchase for cancellation of the XXXXXXXXXX U.S. dollar preferred shares and the issuance of the XXXXXXXXXX Canadian dollar preferred shares on XXXXXXXXXX.
We are of the view that there is a reasonable argument that, based on the facts and circumstances of this case, Holdco did not suffer an exchange rate loss within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Canadian dollar denominated XXXXXXXXXX preferred shares in XXXXXXXXXX. Our position in this regard is based on, inter alia, the following.
First, it should be noted that, from a legal standpoint, no property belonging to Holdco was removed from its patrimony as a result of the purchase for cancellation of the preferred shares of its capital stock denominated in U.S. dollars and the issuance of preferred shares denominated in Canadian dollars. In other words, it appears that the value of Holdco, which is a function of the value of the assets it owns, was not affected in any way by the purchase for cancellation of the U.S. dollar preferred shares or by the issuance of the Canadian dollar preferred shares. Thus, it appears that before or after the transactions described in (1)(n) above, a third party would have paid the same price to acquire all of the shares in the capital stock of Holdco. In these circumstances, we are of the view that there is a reasonable argument that Holdco did not incur a foreign exchange loss within the meaning of subsection 39(2) as a result of the transactions described in (1)(n) above.
It can be argued that the only effect of the purchase for cancellation of the U.S. dollar preferred shares of Holdco's capital stock and the issuance of the Canadian dollar preferred shares of Holdco's capital stock was to alter, for the future, the rights of the shareholders of the various classes of Holdco's shares with respect to its assets. Again, in the present case, this remains theoretical since, at all relevant times, Holdco's shareholding consisted of only one shareholder, Parentco.
The taxpayer representatives insist that the issuance of the XXXXXXXXXX preferred shares, denominated in Canadian dollars, constituted a payment and that Holdco paid more, in Canadian currency, to purchase the XXXXXXXXXX preferred shares of its capital stock. The taxpayers' representatives argue that this is sufficient to conclude that Holdco had sustained a foreign exchange loss within the meaning of subsection 39(2) in this file. We disagree with this position. Strictly speaking, the application of subsection 39(2) does not turn on whether or not the taxpayer has paid any amount. Rather, the application of subsection 39(2) requires that the taxpayer sustain a loss as a result of a fluctuation in the value of a foreign currency relative to Canadian currency. To the extent that a taxpayer's patrimony is not affected in any way by a particular transaction, we find it difficult to argue that the taxpayer can suffer a loss as a result of that same particular transaction.
We acknowledge that by engaging in the transactions described in (1)(n) above, Holdco had, effective XXXXXXXXXX, divested itself of any future risk relating to fluctuations in the value of the U.S. currency relative to the Canadian currency, in respect of the U.S. dollar denominated shares of XXXXXXXXXX. In that sense, the transactions described in (1)(n) above had the effect of fixing the amount of Holdco's loss. However, it can be argued that this is insufficient to trigger the application of subsection 39(2). Again, the application of subsection 39(2) requires that the taxpayer sustain a loss as a result of a fluctuation in the value of a foreign currency relative to the Canadian currency. In the circumstances of this case, we are of the view that there is a reasonable argument that the transactions described in (1)(n) above had no effect on Holdco's patrimony that, accordingly, Holdco would not have incurred a loss within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar preferred shares of its capital stock and the issuance of the Canadian dollar preferred shares of its capital stock in XXXXXXXXXX.
Furthermore, we are of the view that there is a reasonable argument that the facts of the MacMillan Bloedel decision must be distinguished from the situation prevailing in the current file. As indicated above, in MacMillan Bloedel, the taxpayer had redeemed its preferred shares by paying their holders cash consideration in U.S. dollars, which is not the case for Holdco in this case. We believe this distinction is important in the context of the application of subsection 39(2). In MacMillan Bloedel, the redemption of preferred shares of the taxpayer's capital stock clearly affected the taxpayer's patrimony. Indeed, the redemption of shares resulted in an outflow of property from the taxpayer's patrimony, namely an amount of cash, in US dollars. The taxpayer in MacMillan Bloedel had paid more, in Canadian currency, to redeem the preferred shares it had issued than it had received when they were issued, and the value of its patrimony reflected this additional cost. In the current file, it can be argued that the transactions described in (1)(n) above had no effect on Holdco's patrimony and that, accordingly, Holdco would not have sustained a loss within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar preferred shares of its capital stock and the issuance of the Canadian dollar preferred shares of its capital stock in XXXXXXXXXX. We are also of the view that Strayer J.'s comments in (2) above are strongly coloured by the fact that the taxpayer in MacMillan Bloedel paid the redemption price of the preferred shares by paying cash consideration to the holders. Strayer J.'s words must be interpreted in this context.
In our view, there is a reasonable argument that Holdco will only actually sustain a foreign exchange loss within the meaning of section 39(2) when Holdco redeems the XXXXXXXXXX shares (or shares substituted therefor) by delivering to the holder of those preferred shares (Parentco) assets of its own patrimony as payment. It should be noted that if such a redemption were to be made, Parentco would probably have to recognize a foreign exchange gain at the same time. Thus, the disparity that you had raised in that a loss was claimed by Holdco in XXXXXXXXXX without a corresponding gain being realized by Parentco, would no longer exist.
6) Conclusion
For the reasons set out in (5) above, we are of the view that there is a reasonable argument that, based on the facts and circumstances of this case, Holdco did not sustain a foreign exchange loss within the meaning of subsection 39(2) as a result of the purchase for cancellation of the U.S. dollar denominated XXXXXXXXXX preferred shares and the issuance of the Canadian dollar denominated XXXXXXXXXX preferred shares in 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.