2014-0538591I7 FX losses on CFA wind-up

Principal Issues: 1. Whether subsection 93(2.01) of the Act will limit the shareholder's loss on the disposition of CFA shares disposed of in a wind-up where the loss is primarily due to FX fluctuations and no exempt dividends had been paid on the shares or shares for which the CFA shares were substituted. 2. Whether the reasoning in 2012-0436921I7 is applicable to deny the shareholder's loss on the disposition of CFA shares disposed of in a wind-up where the loss is primarily due to FX fluctuations.

Position: 1. No. 2. No.

Reasons: 1. Without the payment of exempt dividends, paragraph 93(2.01)(a) will not operate to reduce the loss. 2. The situation in 2012-0436921I7 is factually different from the case at hand.

Author: Moore, Eli Kae
Section: 40(3.6), 69(5), 88(3), 84(9), 93(2.01)

                                                                                                                                                      August 15, 2014        

      QUEBEC REGION                                                                                                                  HEADQUARTERS
      Montreal Tax Services Office                                                                                                   Income Tax Rulings
      Aggressive Tax Planning Section                                                                                            Directorate
      Attention:  Louis Luponio                                                                                                         Eli Kae Moore
                                                                                                                                                      (613) 957-2104

                                                                                                                                                       2014-053859

      Foreign Exchange based capital losses on the winding-up of a controlled foreign affiliate

We are writing in response to your email of July 2, 2014, and further to our telephone conversation of August 5, 2014 (Moore/Luponio).  You asked for comments on the availability of certain loss prevention rules in respect of a foreign exchange loss realized by a Canadian resident corporate shareholder (hereinafter the “shareholder”) on the winding-up of its wholly owned controlled foreign affiliate (hereinafter the “CFA”).  In the situation you described, the shareholder had not made an election causing the liquidation and dissolution to be a qualifying liquidation and dissolution for the purposes of subsection 88(3.1) of the Income Tax Act (the “Act”), which would alter the determination of the taxpayer’s proceeds of disposition under subsection 88(3) of the Act or as the subsection would read if the shareholder had made an election under subsection 65(2) of the Technical Tax Amendments Act, 2012 (Bill C-48, 1st Sess, 41st Parl).  Specifically, you requested our views as to:

1.    whether subsection 93(2.01) of the Act will limit the shareholder’s loss from the disposition of the CFA shares where there were no exempt dividends paid on the shares or shares for which the CFA shares were substituted and where the loss is primarily due to foreign exchange fluctuations; and

2.    whether the reasoning in internal technical interpretation 2012-0436921I7 is applicable to deny the shareholder’s loss on the disposition of the CFA shares where the disposition is the result of the winding-up of the foreign affiliate and the loss is primarily due to foreign exchange fluctuations.

Our Comments

Loss limitation on disposition of shares of foreign affiliate

Assuming that the shares of the CFA are disposed of for the purposes of the Act when the CFA is wound-up, subsection 84(9) will apply to deem the shares to have been disposed of by the shareholder to the CFA being wound-up.  Subsection 93(2.01) of the Act will then deem any loss experienced by the shareholder on the disposition of the shares to be the greater of the amounts determined under paragraphs (a) and (b) of the subsection.  Once calculated, the amount determined under paragraph 93(2.01)(a) must then be compared to the foreign currency related losses determined under paragraph (b).  If no exempt dividends had been paid on the CFA shares or shares for which the CFA shares were substituted, then the amount determined under paragraph 93(2.01)(a) will not be less than the particular loss determined without reference to the subsection.   

Loss on redeemed or cancelled shares

Internal technical interpretation 2012-0436921I7 addressed a situation where a corporation resident in Canada owned shares in a foreign subsidiary, the subsidiary redeemed certain shares owned by the corporation resident in Canada, and the two corporations remained affiliated immediately after the redemption.  In that situation, 2012-0436921I7 explains that subsection 40(3.6) would operate to deem any loss from the disposition of the shares on their redemption to be nil.

In the situation you have described to us any disposition is not due to a redemption of the shares of an affiliated corporation but is instead due to the winding-up of a corporation affiliated with the shareholder.  Where a disposition of the shares is, as discussed above, on account of the winding-up of the CFA and where property of the CFA had been appropriated by the shareholder during the taxation year of the CFA, then paragraph 69(5)(d) of the Act would apply.  Paragraph 69(5)(d) states that subsection 40(3.6) of the Act does not apply in respect of any property (which would include the shares) disposed of on the winding-up.  Furthermore, the application of subsection 40(3.6) requires that the taxpayer disposing of the shares disposes of them “to a corporation that is affiliated with the taxpayer immediately after the disposition.”  In the case of the winding-up of the CFA, we question how the CFA could be affiliated with the taxpayer immediately after the disposition as we would expect that, under the foreign corporate law, the CFA would cease to exist and its shares would simultaneously be cancelled when the CFA was wound-up.  To summarize, the reasoning in 2012-0436921I7 is not applicable to the case at hand due to the factual differences between the two situations.

We trust our comments will be of assistance.

Yours truly,

Lori M. Carruthers CPA, CA
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy Regulatory Affairs Branch

cc:   International and Large Business Directorate
        Aggressive Tax Planning Division
        Non-Resident Trust and Foreign Investment Entities Section
        344 Slater Street
        Canada Bldg, 5th Floor
        Ottawa, Ontario K1A 0L5

        International and Large Business Directorate
        International Tax Division
        International Advisory Services Sections
        344 Slater Street
        Canada Bldg, 6th Floor
        Ottawa, Ontario K1A 0L5

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