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G. C. Boehmer (613) 993-6201
January 6, 1986
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Re: Foreign Exchange Loss - Subsection 87(7) of the Income Tax Act
This is in reply to your letter of November 7, 1985 in which you requested our opinion with respect to the tax treatment of losses incurred on the repayment of an obligation denominated in a foreign currency in the circumstances described below.
Situation 1
Corporation A, a taxable Canadian corporation, within the meaning of paragraph 89(1)(i) of the Income Tax Act (the "Act") acquires from vendor X all the shares of Corporation B, another taxable Canadian corporation, together with certain notes denominated in U.S. dollars, representing indebtedness of Corporation B to X.
At the time that the notes were issued by Corporation B, the U.S. dollar was worth Cdn. $1.20. At the time that the shares and notes were purchased by Corporation A, the U.S. dollar was worth Cdn. $1.25. Now the U.S. dollar is worth Cdn. $1.35. Corporation A wishes to liquidate Corporation B in order to combine the business operations.
In this hypothetical situation, the debtor, Corporation B, has an accrued currency loss of 15 cents on the dollar. On the creditor's side, a gain of 5 cents on the dollar has already been realized by X, the former owner of Corporation B, when the notes were sold to Corporation A. The remainder of the gain, another 10 cents on the dollar, is still accrued in the hands of Corporation A.
If the notes payable by Corporation B to Corporation A are settled or extinguished before Corporation B is liquidated by payment of an amount equal to their principal amounts, within the meaning of subsection 248(1) of the Act, we confirm that section 80 of the Act would not apply to Corporation B. Corporation B would sustain a capital loss, within the meaning of subsection 39(2) of the Act, of 15 cents on the dollar. Corporation A would realize a capital gain on the disposition of the notes of 10 cents on the dollar. One half of the capital loss realized by Corporation B would be a net capital loss which may be deducted by Corporation A in computing its taxable income for taxation years commencing after the commencement of the winding-up pursuant to subsection 88(1.2) of the Act. Thus, Corporation A would not be able to deduct Corporation B's 15 cent capital loss against its own 10 cent capital gain.
Situation 2
This situation is the same as described above except that Corporation A transfers the notes (representing the indebtedness of Corporation B to Corporation A) to Corporation C, one of Corporation A's subsidiaries, before Corporation A liquidates Corporation B. We confirm that Corporation A would realize the 10 cent capital gain on the sale of the notes at fair market value to Corporation C. If Corporation A assumes all of Corporation L's liabilities and obligations on the liquidation, subsection 87(7) of the Act would apply by virtue of paragraph 88(l)(e.2) of the Act. If Corporation A, within the same taxation year, settles or extinguishes the notes owing by it to Corporation C by payment of an amount equal to their principal amounts, section 80 would not apply to Corporation A and Corporation A would sustain a 15 cent capital loss. The capital loss of 15 cents realized by Corporation A could then be offset against the 10 cent capital gain sustained.
In accordance with Information Circular 70-6R dated December 18, 1978 issued by the Department of National Revenue this opinion does not constitute an income tax ruling and is not binding on the Department.
Our comments are based on the Act in its present form and do not take into account any of the proposed amendments contained in Bill C-84 tabled in the House of Commons by the Minister of Finance on November 26, 1985.
We trust this information will be of assistance to you.
Yours truly,
for Director
Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch