Principal Issues: What exchange rate should be used to convert foreign denominated debt into Canadian dollars for purposes of the thin capitalization rules?
Position: The relevant spot rate for the day on which the debt was issued should be used to convert the foreign currency amount of the debt into Canadian dollars for purposes of the thin capitalization computations.
Reasons: Subsection 261(2) requires that the relevant spot rate for the day on which a particular amount arose be used to convert an amount expressed in a foreign currency into Canadian dollars.
2015 Canadian Tax Foundation Conference
CRA Roundtable
Question 10 – Thin Capitalization – Debt Denominated in Foreign Currency
Where a specified non-resident shareholder of a Canadian corporation (“Canco”) makes a contribution in foreign currency to Canco in exchange for shares of Canco and a loan denominated in foreign currency, the paid-up capital amount of the shares is denominated in Canadian dollars at the time the shares are issued, thus effectively fixing the “equity amount” in Canadian dollars for the thin capitalization ratio in subsection 18(4) of the Income Tax Act (“Act”). However, when determining the amount of the “outstanding debts to specified non-residents” at any particular time, what foreign exchange rate should be used to determine that amount in Canadian dollars: the exchange rate on the date the debt arose (i.e., the loan was issued) or the exchange rate on each calculation date?
CRA Response
Subsection 261(2) of the Act is applicable when determining the amount of outstanding debts to specified non-residents for purposes of the thin capitalization computation in subsection 18(4) of the Act. Provided a taxpayer did not make a functional currency election under subsection 261(3), subsection 261(2) requires that Canadian currency be used in determining the Canadian tax results of the taxpayer and an amount expressed in foreign currency be converted to Canadian currency using the relevant spot rate for the day on which the particular amount arose. Since in the situation described, the amount of the debt arose when the loan was issued, the foreign currency amount of the loan should be converted to Canadian dollars for purposes of the computation in subsection 18(4) using the relevant spot rate for the day on which the loan was issued.
Judy Ho
2015-061060
November 24, 2015