2014-0560571I7 Paid-up capital reduction of a foreign affiliate

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Did a corporation resident in Canada make a foreign exchange gain under subsection 39(2) when it received an amount from its foreign affiliate on the reduction of the paid-up capital of the foreign affiliate in respect of shares owned by the corporation?

Position: No.

Reasons: Scheme of the Act - paragraph 53(2)(b) applies and reduces the ACB to Canco of the capital stock of a foreign affiliate by the full Canadian dollar amount of the PUC reduction received.

Author: Storr, Keely

Section: 39(2); 40(3); 53(2)(b); and 261(2) of the Act

                                                                                                                                         January 22, 2015

      XXXXXXXXXX Tax Services Office                                                                            HEADQUARTERS
      Large Files                                                                                                                  Income Tax Rulings
      Attention:  XXXXXXXXXX                                                                                           Directorate
                                                                                                                                          International Division
                                                                                                                                          K. Storr
                                                                                                                                          (613) 957-8284


      Paid-up Capital Reduction by a Foreign Affiliate

We are writing in response to your memorandum of December 5th, 2014 in which you requested our view as to the application of subsection 39(2) of the Income Tax Act (the “Act”) in a particular situation.

Unless otherwise stated, every reference herein to a section, subsection, paragraph, subparagraph, or clause is a reference to the relevant provisions of the Act.

The following hypothetical circumstances will be used to address your request:

1.    A corporation (“Canco”), that is resident in Canada for the purposes of the Act, owns 100% of all issued and outstanding common shares of a corporation (“Foreignco”) that is a non-resident of Canada for the purposes of the Act.
2.    Canco invested US $200M in Foreignco common shares. This amount was added to the legal stated capital of the Foreignco common shares. At the time of the investment, the exchange rate was $1US = $1 Canadian. As a result, the shares have an adjusted cost base (“ACB”) of $200M.
3.    Subsequently in 2009, Foreignco paid Canco US $99M on a reduction of paid-up capital (“PUC”) of the common shares of Foreignco. That amount expressed in Canadian currency using the relevant spot rate on the date that the amount arose, was $108.9 M.
4.    Canco reports its Canadian tax results, as that term is defined in subsection 261(1), in Canadian dollars.

You enquired as to whether there is a foreign exchange gain made by Canco for purposes of subsection 39(2) on the reduction of PUC in respect of the common shares of Foreignco.

Our comments

It is our view that on the reduction of PUC of the common shares of Foreignco, there is no foreign exchange gain made by Canco for purposes of subsection 39(2). Our rationale is as follows. Paragraph 53(2)(b) provides that certain amounts shall be deducted from the ACB to a taxpayer of a share of the capital stock of a non-resident corporation. Subparagraph 53(2)(b)(ii) as it read in the year at issue provides that the ACB of a share of a non-resident corporation to a taxpayer is to be reduced by any amount that is received by the taxpayer on a reduction of the paid-up capital in respect of the share.

Subsection 261(2) of the Act provides that in determining the Canadian tax results of a taxpayer Canadian currency is to be used and if a particular amount that is relevant in computing those Canadian tax results is expressed in a currency other than Canadian currency, the particular amount is to be converted to an amount expressed in Canadian currency using the relevant spot rate for the day on which the particular amount arose.

As such, the Canadian dollar equivalent ($108.9M) of the amount received by Canco in 2009 in satisfaction of the reduction of PUC of the common shares, would be deducted in computing the ACB to Canco of Foreignco’s common shares pursuant to former subparagraph 53(2)(b)(ii). If the total of all amounts received by Canco on reductions of PUC by Foreignco were to exceed the ACB to Canco of the common shares of Foreignco, Canco would be deemed to have a gain pursuant to subsection 40(3). (footnote 1)   Alternatively, if no subsection 40(3) arises, subsection 40(1) provides for the computation of a gain or loss based on the ACB to Canco of the shares of Foreignco as reduced under paragraph 53(2)(b) when the shares are disposed of by Canco.  Therefore, whether it is subsection 40(1) or subsection 40(3) that applies, the full amount deducted from the ACB to Canco of the Foreignco shares under paragraph 53(2)(b) in 2009 will  be reflected in the eventual gain or loss realized by Canco on the Foreignco shares.

An argument could be made that for the purposes of subsection 39(2), Canco “made a gain” because of a fluctuation in the value of US currency relative to Canadian currency in the same way that a lender might make a gain on the repayment of a portion of a foreign currency denominated loan. However, in our view, the Act contemplates a different scheme for an investment in shares, as outlined above. If subsection 39(2) were also applicable, the accretion in the value of the share investment attributable to foreign currency fluctuation would be duplicated in the gain computed under subsection 39(2) and any potential gain calculated in respect of the shares under section 40. For these reasons it is our view that subsection 39(2) would not apply in these circumstances and for the same reasons we would not agree that a loss would be computed under subsection 39(2) if US currency had declined in value relative to Canadian currency prior to the PUC reduction by Foreignco.

In summary, it is our view that the amount received by Canco in 2009 on a reduction of PUC in respect of the shares of the capital stock of Foreignco, will reduce the ACB to Canco of the shares of Foreignco under paragraph 53(2)(b). The amount of the ACB reduction is to be expressed in Canadian currency using the relevant spot rate for the day on which the PUC reduction was received. No gain or loss will be computed under subsection 39(2) in respect of said reduction. Thus the amount deducted from the ACB of the shares of Foreignco held by Canco in this situation would be $108.9M.

It is important to note that after August 19, 2011 a distribution made by a foreign affiliate on a reduction of PUC, such as that made by Foreignco to Canco in 2009, will generally be deemed to be a dividend pursuant to subsection 90(2) unless an election is made pursuant to subsection 90(3) in accordance with the prescribed rules.

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library.  A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases.  The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer.  Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity.  Requests for this latter version should be e-mailed to: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès.  In such cases, a copy will be sent to you for delivery to the taxpayer.

We hope our comments are of assistance to you.


Olli Laurikainen, CPA, CA
For Director
International Division
Income Tax Rulings Directorate

Cc Mark Turnbull


Note to reader:  Because of our system requirements, the footnotes contained in the original document are shown below instead:


1  If such deemed gain arose in a taxation year of Canco that began on or before August 19, 2011, and was wholly attributable to fluctuation in the value of the US currency relative to Canadian currency it would be a subsection 39(2) capital gain. However, if such capital gain arose in a later taxation year of Canco, it would fall into subsection 39(1). This is so because the preamble of current subsection 39(2) excludes from that subsection, amongst other things, any capital gain or capital loss to which subsection 39(1) applies. As a result foreign exchange gains and losses in respect of asset dispositions by a corporation are now determined exclusively under subsection 39(1). 

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© Her Majesty the Queen in Right of Canada, 2015

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