2014-0540631I7 S.261 and loss carryback request

Principal Issues: Where an amount is deducted under paragraph 111(1)(a) for a taxation year in respect of a subsequent year non-capital loss, in recalculating a functional currency elector’s CAD taxes payable for that taxation year in order to compute the reporter’s refund, a. which instalment method should be used, and b. should previously deducted non-capital losses from other subsequent years be considered?

Position: a. There is no statutory required method, it is reasonable to use the method that results in the least total Canadian dollar taxes payable. b. All subsequent year non-capital losses that have previously been deducted under paragraph 111(1)(a) should be considered.

Reasons: a. No instalment method dictated by paragraphs 157(1)(a) or (b) or 261(11)(a) or (b). b. A deduction in a particular taxation year under paragraph 111(1)(a) is the total amount claimed in respect of losses for the 20 preceding and 3 subsequent taxation years. There are no exceptions similar to subsection 161(7) that would apply where the deduction is in respect of a loss for a subsequent taxation year.

Author: Johns, Jeffrey
Section: 157(1), 161(7), 162(11), 248(1) - definition of "specified future tax consequences", 261(3), 261(5), 261(11)

                                                                                                                                                    January 21, 2015

Attention: Kathleen McCaffrey                                                                                                     HEADQUARTERS
Canada Revenue Agency                                                                                                            Income Tax Rulings
Assessment and Benefit Services Branch                                                                                   Directorate
Business Accounting Division                                                                                                      Jeffrey Johns
Business Accounting Programs Section                                                                                      (416) 973 9084
750 Heron Road,
Ottawa, ON, K1A 0L5                                                                                                                  2014-054063

Section 261 and Loss Carrybacks

We are writing you in reply to your email of July 21, 2014 in which you have posed a number of questions regarding the calculation of a refund of a taxpayer that has elected under the Income Tax Act (the “Act”) to report its income in a currency other than the Canadian dollar (“CAD”), for a particular taxation year, after that taxpayer carries a loss reported in a subsequent year back to that taxation year.  We also note the additional emails and phone conversations (Johns/Demeter/McCaffrey) regarding this issue.

The specific taxpayer in this case is XXXXXXXXXX (“Canco”).  Canco is a corporation resident in Canada.  Canco has also elected to be a functional currency tax reporter such that, for each of Canco’s previous five taxation years (starting with the earliest taxation year “Year 1” to “Year 5”, respectively), subsection 261(5) has applied to Canco and it has reported its income for income tax purposes for each of those years in its elected functional currency (“EFC”); the currency of the United States.  Canco initially reported taxable income and tax payable in Year 1, Year 2, and Year 3, and reported a non-capital loss in each of Year 4 and Year 5.  Canco has claimed a deduction under paragraph 111(1)(a) in determining its taxable income for Year 1 for its non-capital losses from Year 4, as well as a deduction under paragraph 111(1)(a) in determining its taxable income in Year 2 for its non-capital losses from Year 4 and Year 5. 

Canco has questioned the methodology used by the Agency in determining the amount of its refund.  In considering Canco’s questions, you have asked for our views regarding the determination of a refund of tax of a taxpayer that reports its income in its EFC, pursuant to subsection 261(5). 

Specifically, you have asked:

Where an amount is deducted under paragraph 111(1)(a) for a particular taxation year in respect of a non-capital loss for a subsequent taxation year, in recalculating a functional currency reporter’s taxes payable and computing the reporter’s refund for the particular taxation year: 

a.    which instalment method should be used;

b.    should previously applied non-capital losses from subsequent years be considered?

In considering these questions, we based our comments on our understanding of the present approach employed by your directorate in determining the Part I taxes payable by, or refund owing to a functional currency reporter, and we note the following important points in respect of that approach:

*     A reporter’s taxes payable in CAD for a taxation year are equal to the CAD total of its instalment obligations for the year, as determined under paragraph 261(11)(a), and its remainder of taxes payable, as determined under paragraph 261(11)(b).
*     Each time that a reporter’s CAD taxes payable are determined for a particular year, each instalment method (endnote 1) will be considered in applying paragraphs 261(11)(a) and (b), with the reporter assessed using the instalment method that results in the least amount of CAD taxes payable for the year.
*     In applying subparagraph 261(11)(a)(i) in determining a reporter’s CAD taxes payable for the year, the reporter’s CAD instalment obligations under the estimated instalment method will be computed by considering the reporter’s assessed EFC taxes payable for the year, as that amount is determined in that currency before the application of paragraphs 261(11)(a) and (b), to be the reporter’s estimated taxes payable for the year for purposes of subparagraph 157(1)(a)(i).  More specifically, in these circumstances, each monthly instalment obligation computed under subparagraph 157(1)(a)(i) will be equal to 1/12 of the assessed EFC taxes payable expressed in that currency, converted to CAD on the date each instalment is due.
*     The use of the instalment method in either subparagraph 157(1)(a)(ii) or (iii), as they apply after the application of subparagraphs 261(11)(a)(ii) and (iii), may result in a total of instalment obligations for the year, when expressed in a reporter’s EFC, that exceeds the reporter’s assessed EFC taxes payable as determined before the application of paragraphs 261(11)(a) and (b).  Where this occurs under either instalment method, that particular method will not be considered.  Where both methods in subparagraphs 157(1)(a)(ii) and (iii) result in this excess, the estimated method described in subparagraph 157(1)(a)(i) will be used in applying paragraphs 261(11)(a) and (b) for purposes of determining a reporter’s CAD taxes payable.

As your questions relate solely in respect of the computation of taxes arising under Part I of the Act, each of our references below to taxes payable, unless otherwise indicated, refers solely to taxes payable arising under that part.  

Our comments

A response to the questions that you raised requires consideration of the inter-relationship between section 261, a taxpayer’s instalments as calculated under subsection 157(1), and the determination of the taxpayer’s taxes payable for the year. 

Determination of a functional currency reporter’s instalment obligations and taxes payable

Where certain requirements are met, subsection 261(3) of the Act permits a corporation resident in Canada to elect to report its income for purposes of the Act in its EFC.  Where a corporation has made this election, subsection 261(5) provides that, in general, all amounts relevant to the determination of the functional currency reporter’s income taxes are computed in the reporter’s EFC.

However, notwithstanding subsection 261(5), we are of the view that subsection 261(11) requires that a functional currency reporter’s income taxes payable, along with certain other amounts specified in that provision, be determined and paid in Canadian currency.  Subsection 261(11) also provides the rules by which a functional currency reporter’s income taxes payable arising under any of the parts of the Act are translated into a Canadian currency amount.  Where the taxes payable arise under a part of the Act that imposes payment by instalments, as is the case with Part I, this translation is governed by paragraphs 261(11)(a) and (b).  These paragraphs incorporate the initial computation of a functional currency reporter’s taxes payable as determined in the reporter’s EFC, in order to determine the reporter’s ultimate taxes payable, as determined in CAD.  For ease of reference, we have referred to these amounts below as a reporter’s “EFC Taxes Payable” and “CAD Taxes Payable”, respectively.

Paragraph 261(11)(a) determines the functional currency reporter’s CAD instalment obligations under paragraph 157(1)(a) for a tax year, while paragraph 261(11)(b) determines the reporter’s remainder of CAD Taxes Payable (if any) under paragraph 157(1)(b).  Paragraphs 261(11)(a) and (b) contemplate the use by a functional currency reporter of any of the instalment methods described in subparagraph 157(1)(a)(i) (“Estimated Method”), (ii) (“First Instalment Base Method”), or (iii) (“Second Instalment Base Method”).  The Rulings Directorate described in detail our views regarding the operation of paragraphs 261(11)(a) and (b) in Document 2009-0332771E5.  In summary:

*     instalment obligations under paragraph 261(11)(a)

o     A functional currency reporter’s instalment obligations under the Estimated Method are determined by taking 1/12 of the taxpayer's EFC Taxes Payable for the year and converting this amount to CAD at the relevant spot rate for the day that an instalment is due.

o     The taxpayer's instalment obligations under the First Instalment Base Method or Second Instalment Base Method are based on the reporter’s CAD Taxes Payable for its previous taxation year or previous two taxations years, as the case may be. 

*     remainder of taxes payable under paragraph 261(11)(b)

o     To compute a functional currency reporter’s remainder of taxes payable, each of the reporter's required CAD instalment payment obligations are converted to the reporter's EFC using the relevant spot rate for the day each of the instalments was due.  The total of the required instalments, as expressed in the reporter's EFC, is then deducted from the reporter's EFC Taxes Payable for the year and the difference, if any, is converted to Canadian currency using the relevant spot rate on the reporter's balance-due day. 

In this regard, we note that there will be no remainder of taxes payable determined under paragraph 261(11)(b) where the Estimated Method is used.  We also note that, even where either the First Instalment Base Method or Second Instalment Base Method is used, paragraph 261(11)(b) will only result in a remainder of taxes payable to the extent that the total instalment payments, first determined in CAD under paragraph 261(11)(a), then converted to an amount denominated in a functional currency reporter’s EFC under paragraph 261(11)(b), (endnote 2) are less than the reporter’s EFC Taxes Payable for the year.  As the total amount of a functional currency reporter’s required instalments, as converted to an EFC-denominated amount, is relevant to the further discussion below, for ease of reference we have referred to this amount as a reporter’s “Total EFC Instalments” for a taxation year.

In effect, by providing a method by which each of a functional currency reporter’s instalment obligations and its remainder of taxes payable are all determined as CAD amounts, the application of paragraphs 261(11)(a) and (b) results in the conversion of the reporter’s EFC Taxes Payable into CAD amounts that, when added together, represent the reporter’s CAD Taxes Payable for the year. In the absence of subsection 261(11), the functional currency reporter’s instalment obligations and its remainder of taxes payable would otherwise be determined in the reporter’s EFC. As the Technical Notes to subsection 261(11) explain, by tying the translation of a functional currency reporter’s EFC Taxes Payable into its CAD Taxes Payable to the relevant instalment obligation dates and balance due date, the reporter is insulated from foreign currency risk on these amounts to the extent that they actually make those payments on those dates. (endnote 3)  

In this regard, we are of the view that the approach of your directorate in determining a functional currency reporter’s taxes payable in CAD is consistent with our interpretation of paragraphs 261(11)(a) and (b), as is the use of the reporter’s actual EFC Taxes Payable for the taxation year as the base for determining the reporter’s CAD instalment obligations using the Estimated Method.

Initial choice of instalment method for taxation year of a functional currency reporter

As we discussed in our letter to you dated August 29, 2011, (endnote 4) based on the 2005 decision of the Tax Court of Canada I.G. Rockies Corp. v The Queen, (endnote 5) we are of the view that a corporation may opt for whichever instalment method under paragraph 157(1)(a) that it wishes, regardless of the instalment method that is deemed by subsection 161(4.1) to have been used for purposes of computing the corporation’s interest in respect of unpaid or late instalments.  While paragraph 261(11)(a) does modify the reading of paragraph 157(1)(a) as it applies to a functional currency reporter, it does not specifically place any restriction on which of the three instalment methods is to be used to determine the reporter’s instalment payments.  As a result, in our view, a corporation’s functional currency election and status as a functional currency reporter does not hinder its ability to choose what it considers to be the most appropriate instalment method under paragraph 157(1)(a).

As noted above, we understand that when applying paragraphs 261(11)(a) and (b) to determine the remainder of taxes payable of a functional currency reporter in CAD, your directorate will not consider the use of either the First Instalment Base Method or the Second Instalment Base Method where a reporter’s Total EFC Instalments using the respective instalment method exceed the reporter’s EFC Taxes Payable for the year.  In our view, notwithstanding the lack of legislative restriction regarding a functional currency reporter’s instalment method, this is a reasonable and appropriate approach to applying paragraphs 261(11)(a) and (b) as it ensures that the determination of CAD Taxes Payable for a taxation year is always based on the amount of the reporter’s EFC Taxes Payable for that taxation year. 

As we also noted above, we understand that each assessment of the CAD Taxes Payable of a functional currency reporter will consider all three instalment methods, and assess using the instalment method that gives rise to the least amount of CAD Taxes Payable.  In our view, this approach to the determination of CAD Taxes Payable of a functional currency reporter is also reasonable, as the wording of the Act, itself, does not appear to restrict a functional currency reporter in its choice of instalment method when applying paragraphs 261(11)(a) and (b).  This approach to application of the provision is not, in our view, inconsistent with the stated intention of the legislators in drafting paragraphs 261(11)(a) and (b), which was to provide a functional currency reporter with a limited amount of foreign exchange insulation in respect of taxes payable. (endnote 6) 

Choice of instalment method when re-determining taxes payable of a functional currency reporter after the deduction of a subsequent year loss

Subparagraph 161(7)(a)(iv) acts to ensure that any interest or penalties assessed under section 161 to a corporation in respect of late or unpaid instalments are determined before considering the consequences of the deduction of any deduction under section 111 in respect of a loss for a subsequent year.  Therefore, when a corporation that is not a functional currency reporter deducts an amount under paragraph 111(1)(a) in a particular taxation year in respect of a subsequent year non-capital loss, there is generally no need to revisit the determination of that corporation’s instalment obligations or remainder of taxes payable for that particular taxation year.  Subparagraph 161(7)(a)(iv) will also apply to a functional currency reporter so that losses carried back to a taxation year of the reporter do not affect any interest or penalties from unpaid instalments in respect of that year.  However, unlike a non-reporter, the total of a reporter’s instalment obligations and remainder of taxes payable for each taxation year also represent the reporter’s CAD Taxes Payable for the year.  Therefore, it is appropriate to re-determine these amounts for any taxation year in which a loss for a subsequent year is applied, in order for a revised amount of CAD Taxes Payable to be determined.  In this regard, we note that neither subparagraph 161(7)(a)(iv), nor any other provision in the Act applies to limit either paragraphs 157(1)(a) or (b) or paragraphs 261(11)(a) and (b) in their application to determine a revised amount of CAD Taxes Payable in respect of a taxation year, as a result of a future tax loss being carried back to that year.

Response to your questions

In light of the above-noted comments, we will consider these views in the context of your more specific questions.

Question a. Which instalment method should be used in recalculating CAD Taxes Payable resulting from a paragraph 111(1)(a) deduction for a subsequent year non-capital loss?

On first consideration, it may appear that, when re-determining the CAD Taxes Payable for a particular taxation year as a result of a deduction under paragraph 111(1)(a) in respect of a loss for a subsequent year, the same instalment method that was originally used for the particular year should also be used to recalculate the CAD Taxes Payable. However, in our view, just as the provisions of section 261 do not mandate the use of one of the instalment methods in paragraph 157(1)(a) for a functional currency reporter’s current tax year, nor do they appear to place any restrictions on the choice of instalment method when recalculating the CAD Taxes Payable for a previous tax year after a loss is carried back to that year. 

However, when applying paragraphs 261(11)(a) and (b), the previously-noted scenario in which the use of the Estimated Method is the only appropriate instalment method (i.e., where the reporter’s Total EFC Instalments exceed its EFC Taxes Payable under the other instalment methods) could also occur in recalculating a reporter’s CAD Taxes Payable for a taxation year after a deduction of subsequent year losses.  For example, consider a situation where a functional currency reporter had originally used the First Instalment Base Method in respect of a taxation year.  Subsequently, the reporter claims a deduction of a non-capital loss from a subsequent taxation year, resulting in the Total EFC Instalments for the current taxation year exceeding the reporter’s EFC Taxes Payable for the year. In these circumstances, it would not be appropriate to maintain the use of the First Instalment Base Method when applying paragraph 261(11)(b) in re-determining the reporter’s CAD Taxes Payable after the amount of the subsequent year loss is applied.

Question b. Should previously applied non-capital losses from subsequent years be considered in recalculating CAD Taxes Payable resulting from a subsequent deduction for an additional non-capital loss?

Paragraph 111(1)(a) permits a deduction from taxable income equal to the total amount claimed in respect of losses for the twenty preceding and three subsequent taxation years.  Where the amount of a paragraph 111(1)(a) deduction claimed by a taxpayer for a particular taxation year is initially assessed and subsequently amended as a result of the application of a loss from a subsequent year, each successive amendment requires a re-determination of the total amount deducted under paragraph 111(1)(a), as well as the taxpayer’s taxable income and the taxes payable for that particular taxation year.  Therefore, in circumstances where losses arising in two or more years, prior or subsequent, are applied in a particular year, the successive determination of the total amount to be deducted under 111(1)(a) requires consideration of all prior and subsequent losses that are claimed by the taxpayer in the year.

As discussed above in our comments regarding the effect of a subsequent loss carry back on a functional currency reporter’s instalment obligations, subsection 161(7) applies for the specific purpose of determining interest and penalty in respect of unpaid taxes or instalment obligations of a taxpayer.  Subsection 161(7) ensures these amounts are computed without taking into consideration the reduction in taxes payable resulting from any deduction of losses from subsequent years.  However, as also stated above, no similar provision exists that would exclude such a deduction from the determination or redetermination of a taxpayer’s actual instalment obligations, nor from the determination of the remainder of taxes payable in respect of a taxation year under paragraphs 157(1)(a) and (b).  Nor is there an exclusionary provision in respect of the application of paragraphs 261(11)(a) and (b) for purposes of the determination or redetermination of instalment obligations or remainder of taxes payable in respect of a taxation year, and resulting total CAD Taxes Payable for that year, of a functional currency reporter. 

Therefore, in our view, there is no provision in the Act that would, in re-determining a functional currency reporter’s CAD Taxes Payable for a taxation year as the result of a loss carried back to that year, prevent consideration of each prior amount of a loss that was previously applied in that year.

We trust our comments above are helpful for your purposes.

Yours truly,

Robert A. Demeter, CPA, CGA
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc:   Lisa Rondeau - Director, Business Accounting Division, Business Returns Directorate, Assessment and Benefit Services Branch
Mike O’Brien - Manager, Business Accounting Section, Business Accounting Division, Business Returns Directorate, Assessment and Benefit Services Branch

ENDNOTES

1  Described under paragraphs 157(1)(a) or (1.1)(a), as applicable.
2  This conversion is contained in clause 261(11)(a)(i)(B).
3  Feb. 2009 TN (budgets/technical).
4  IT Rulings Document 2011-0397071I7
5  2005 DTC 289 (TCC)
6  Feb. 2009 TN (budgets/technical).

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