2014-0544651I7 Section 85 transfer of Swap Contracts

Principal Issues: 1. Whether swaps are inventory and eligible property for a subsection 85(1) transfer. 2. Whether the subsection 85(1) T2057 election was invalid.

Position: 1. Yes 2. No

Reasons: 1. Prior positions taken by the CRA. 2. The error was of a clerical nature and the election is valid.

Author: Ferrari, Rob
Section: 85, 85(1.1)

January 29, 2015

                                                                           HEADQUARTERS
                                                                           Income Tax Rulings Directorate
XXXXXXXXXX Tax Services Office                   R. Ferrari         
                                                                           (613) 952-8283

                                                                           2014-054465

          XXXXXXXXXX (“Taxpayers”)

This memorandum is in reply to your submission of September 2, 2014, wherein you requested our views with respect to certain swap agreements (the “Swap Contracts”), which were transferred under subsection 85(1) of the Income Tax Act (the “Act”). 

XXXXXXXXXX.  The TSO and the Taxpayer have requested our views with respect to the following two questions:

*     whether the Swap Contract could be considered to be inventory for the purposes of paragraph 85(1.1)(f) of the Act, and,

*     whether the elections filed on Form T2057 “Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation” (“T2057”) were valid elections.

Our understanding of the facts with respect to these questions is as follows:

1.    XXXXXXXXXX is a XXXXXXXXXX corporation listed on the XXXXXXXXXX Exchange.

2.    XXXXXXXXXX is XXXXXXXXXX corporation and all of its common shares are indirectly owned by XXXXXXXXXX.

3.    A Revolving Swap Facility Agreement (“RSFA”) dated XXXXXXXXXX was entered into between XXXXXXXXXX and XXXXXXXXXX.  The RSFA granted XXXXXXXXXX a revolving currency swap facility permitting XXXXXXXXXX to swap U.S. dollars for Canadian dollars or Canadian dollars for U.S. dollars.  XXXXXXXXXX issued notes in U.S. dollars in each of the years XXXXXXXXXX to XXXXXXXXXX.  The net proceeds from the issuances were used to repay existing indebtedness and for other general corporate purposes.  In respect of these notes, XXXXXXXXXX entered into Swap Contracts with XXXXXXXXXX.  The Swap Contracts provided that XXXXXXXXXX would pay an agreed Canadian dollar amount to XXXXXXXXXX and XXXXXXXXXX would pay an agreed U.S. dollar amount to XXXXXXXXXX at maturity.

4.    In each year of XXXXXXXXXX and XXXXXXXXXX, XXXXXXXXXX subscribed for common shares in XXXXXXXXXX companies for nominal amounts and shortly thereafter transferred its rights under each of the Swap Contracts to the new corporations.  The purchase price that the parties agreed to on the transfers was the fair market value of XXXXXXXXXX rights under each of the Swap Contracts on the date of the transfers. 

5.    The transfers were subject to elections under subsection 85(1) and Forms T2057 “Election on Disposition of Property by a Taxpayer to a Taxable Canadian Corporation” were filed with respect to the transfers.  The cost and agreed amounts were recorded as $XXXXXXXXXX on each of the elections.  The Swap Contracts were recorded on the line “Security or Debt Obligation Property” in XXXXXXXXXX to XXXXXXXXXX.  On the XXXXXXXXXX Form T2057, “See attached” was written on the line “Security or Debt Obligation Property”.  On the attachment, the description of the property transferred was as follows:

“Right, title and interest to swap Cdn $XXXXXXXXXX into US $XXXXXXXXXX pursuant to a utilization notice dated XXXXXXXXXX”.

6.    Immediately after the transfer of each of the Swap Contracts, the XXXXXXXXXX companies were wound up into XXXXXXXXXX.

7.    The TSO had requested ITRD’s views with respect to various swap transactions undertaken by the Taxpayers.  After taking into account the Taxpayers’ XXXXXXXXXX swaps would be on account of income.

TSO Position

The TSO is of the view that the Swap Contracts do not constitute inventory for the purposes of paragraph 85(1.1)(f) as the cost or value was not relevant in computing the taxpayer’s income.  The TSO is also of the opinion that the election filed on Form T2057 was invalid XXXXXXXXXX.

Our Comments

XXXXXXXXXX.  Accordingly, our comments are limited to the issues of whether the Swap Contracts may be considered to be inventory for the purposes of paragraph 85(1.1)(f) and whether the elections on Forms T2057 are invalid.  Pursuant to paragraph 85(1.1)(f), inventory is eligible property for the purposes of a section 85(1) transfer.  Inventory is defined under subsection 248(1) as follows:

"inventory" means a description of property the cost or value of which is relevant in computing a taxpayer's income from a business for a taxation year or would have been so relevant if the income from the business had not been computed in accordance with the cash method and, with respect to a farming business, includes all of the livestock held in the course of carrying on the business;”

XXXXXXXXXX "in the money position" in a derivative based contract, is a property, as defined in subsection 248(1) of the Act and depending on the facts and circumstances, may qualify as an "eligible property" as defined in subsection 85(1.1).  We also stated that if the derivative was used to hedge a capital debt, it would be an eligible property described in paragraph 85(1.1)(a).  Otherwise, it would be considered an inventory property of XXXXXXXXXX and thus would still be eligible property as described in paragraph 85(1.1)(f).

It is our view that the cost or values of XXXXXXXXXX Swap Contracts are relevant components in the computation of the taxpayer’s income from a business for a taxation year.  Accordingly, based on the facts described above, the Swap Contracts are considered to be inventory for the purposes of paragraph 85(1.1)(f).

With respect to the question as to the validity of the section 85 election on Form T2057, we note that XXXXXXXXXX the Taxpayer’s derivatives could be considered as inventory for the purposes of subsection 85(1), which supports the Taxpayer’s contention that XXXXXXXXXX intention was to record the transfer as inventory.  We have also taken into consideration that the description of the property and values were accurately described.  Accordingly, we think it is reasonable to consider the error was clerical in nature, which in our view, should not, in and of itself, invalidate the election in the particular circumstances described.

We trust our comments will be of assistance.

G. Moore
for Director
Partnerships & Corporate Financing Section
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc
XXXXXXXXXX, Income Tax Audit
XXXXXXXXXX Tax Services Office

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