2014-0561001R3 Functional currency election

Principal Issues: Whether a corporation resident in Canada can elect pursuant to 261(3) to use US currency as its functional currency for Canadian tax reporting purposes, and whether the anti-avoidance provisions in 261(20) and (21) would apply to proposed currency hedging transactions entered into between the electing corporation and other related, non-resident corporations.

Position: Based on the facts presented, the corporation can elect to use US currency as its functional currency for Canadian tax reporting purposes, and for the purposes of determining the electing corporation's income, gain or loss in respect of its proposed currency hedging transactions with related, non-resident corporations, subsection 261(21) will not apply.

Reasons: Provided that the US currency remains the primary currency in which the electing corporation maintains its records and books of account for financial reporting purposes throughout the taxation year in which a timely election is filed, based on the facts presented the requirements of subsection 261(3) are otherwise satisfied. Also, 261(21) will not apply for the purpose of determining the electing corporation's income, gain or loss in respect of its proposed currency hedging transactions with related, non-resident corporations to the extent that the other related, non-resident corporations are not subject to tax under the Act on any amount included in their respective Canadian tax results.

Author: XXXXXXXXXX
Section: Section 261

XXXXXXXXXX
                                                                                                                                                                      2014-056100
XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re:         XXXXXXXXXX
              Business No. XXXXXXXXXX
              Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, in which you request an Advance Income Tax Ruling on behalf of the above named taxpayer.  We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request:

(i)   is in an earlier return of the taxpayer or a related person;

(ii)  is being considered by a Tax Services Office or Taxation Center in connection with a previously filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv)  is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v)   is the subject of a Ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Act, and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated. Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

DEFINITIONS

“A-Co” means XXXXXXXXXX;

“Act” means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended;

“arm’s length” has the meaning ascribed by section 251;

“Back-to-Back Currency Hedging Transaction” means a contract between CanULC and A-Co for the forward purchase or sale of USD, fixing the amount of CAD to be paid or received in respect of USD at a future date, where the amount of CAD to be paid or received under the contract is determined pursuant to a Currency Hedging Transaction between CanULC and either B-Co1 or B-Co2;

“B-Co1” XXXXXXXXXX;

“B-Co2” XXXXXXXXXX;

“CAD” means the currency of Canada;

“Canadian tax results” has the meaning ascribed by subsection 261(1);

“CanULC” means XXXXXXXXXX;

“Commodity” or “Commodities” means XXXXXXXXXX;

“Commodity Contract” means a contract for the purchase or sale of a Commodity with delivery at a date subsequent to the date of contract execution;

“Country A” means the XXXXXXXXXX;

“Country A Treaty” means the Convention between Canada and XXXXXXXXXX;

“Country B” means XXXXXXXXXX;

“Country B Treaty” means the Convention between Canada and XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

“Currency Hedging Transaction” means a contract for the forward purchase or sale of CAD, fixing the amount of USD to be paid or received in respect of CAD at a future date;

“Existing Back-to-Back Currency Hedging Transaction” means any Back-to-Back Currency Hedging Transaction described in paragraph 27 that was entered into by CanULC prior to the Transition Day, and that was unsettled as of the close of the day that was immediately before the Transition Day;

“Existing Currency Hedging Transaction” means any Currency Hedging Transaction described in paragraphs 25 or 26 that was entered into by CanULC prior to the Transition Day, and that was unsettled as of the close of the day that was immediately before the Transition Day;

“Future Back-to-Back Currency Hedging Transaction” means any Back-to-Back Currency Hedging Transaction described in paragraph 35 that was entered into by CanULC on or after the Transition Day;

“Future Currency Hedging Transaction” means any Currency Hedging Transaction described in paragraphs 33 or 34 that was entered into by CanULC on or after the Transition Day;

“IFA” means an internal financing arrangement specifying legal and financial terms for deposits and borrowing between entities within the Pubco Group;

XXXXXXXXXX;

“Pubco” means XXXXXXXXXX;

“Pubco Group” means Pubco and any or all of its subsidiary companies;

“related persons” has the meaning ascribed by subsection 251(2);

“tax reporting currency” has the meaning ascribed by subsection 261(1);

“taxable Canadian corporation” has the meaning ascribed by subsection 89(1);

“Transition Day” means XXXXXXXXXX; and

“USD” means the currency of United States of America.

FACTS

1.    Pubco is a corporation formed under the laws of Country A, all of the issued and outstanding equity of which is listed for trading on the XXXXXXXXXX.

2.    CanULC is a taxable Canadian corporation formed under the XXXXXXXXXX, operating a business in Canada of XXXXXXXXXX and purchase and sale of Commodities from its principal business address at XXXXXXXXXX.

3.    CanULC files its tax returns with the Taxation Centre in XXXXXXXXXX, and its Tax Services Office is located in XXXXXXXXXX.  CanULC has a federal business number of XXXXXXXXXX, and its most recent taxation year ended on XXXXXXXXXX.

4.    A-Co is a corporation formed under the laws of Country A that is a direct, wholly-owned subsidiary of Pubco.  A-Co is a resident of Country A for purposes of the Country A Treaty and a non-resident of Canada for purposes of the Act. 

5.    A-Co uses USD as its reporting currency for tax purposes in Country A.

6.    B-Co1, a corporation formed under the XXXXXXXXXX in Country B, is an indirect, wholly-owned subsidiary of Pubco.  B-Co1 is a resident of Country B for purposes of the Country B Treaty and a non-resident of Canada for purposes of the Act.

7.    B-Co2, a corporation formed under the XXXXXXXXXX in Country B, is a direct, wholly-owned subsidiary of B-Co1.  B-Co2 is a resident of Country B for purposes of the Country B Treaty and a non-resident of Canada for purposes of the Act.

8.    B-Co1 and B-Co2 carry on business in Country B with activities including, but not limited to, the purchase and sale of Commodities through Commodity Contracts.  Whereas the prices for Commodities are generally quoted in USD, certain Commodity Contracts with parties that deal at arm’s length with B-Co1 and B-Co2 involve the purchase or sale of Commodities with delivery in Canada subsequent to the date of the contract’s execution.  A portion of these Commodity Contracts provide for settlement in CAD.

9.    B-Co1 and B-Co2 both use USD as their respective reporting currencies for Country B tax purposes.

10.   A-Co, B-Co1 and B-Co2 do not carry on business in Canada, and are not otherwise subject to tax under the Act on any amount included in their respective Canadian tax results.

11.   Pubco, A-Co, B-Co1 and B-Co2 are all persons related to CanULC pursuant to subsection 251(2).

12.   Under its IFA, CanULC routinely places funds in excess of its daily requirements on deposit with A-Co and, from time-to-time, borrows funds from A-Co.  Interest on deposits with, and borrowings from, A-Co is calculated at rates that an arm’s length bank would otherwise pay or charge to CanULC.

Support for USD as the functional currency of Canco

13.   Pubco reports its consolidated financial results to the public markets in USD.  To support this, Pubco requires its subsidiaries worldwide (including CanULC) to maintain their accounts and report financial results in USD.

14.   CanULC does not independently report its financial results externally other than for Canadian tax purposes.  The financial statements presented to, and approved by, the Board of Directors of CanULC are denominated in USD.

15.   For the period XXXXXXXXXX through XXXXXXXXXX, the average monthly amount of purchases and sales of XXXXXXXXXX by CanULC based upon the currencies for the underlying contracts were as follows:
                               USD         CAD
Transaction Type  (XXXX)      (XXXX)
XXXX purchases    XXXX        XXXX
XXXX sales            XXXX        XXXX

These amounts are considered by management to be representative of a typical month for CanULC.

16.   For the fiscal year ended XXXXXXXXXX, sales of XXXXXXXXXX represented XXXXXXXXXX% of revenues reported on the CanULC entity financial statements prepared for Canadian tax purposes. Applying a XXXXXXXXXX exchange rate to the data above, USD sales comprise XXXXXXXXXX% of total sales, being XXXXXXXXXX sales.

17.   For the fiscal year ended XXXXXXXXXX, purchases of XXXXXXXXXX represented XXXXXXXXXX% of the expenses reported on the CanULC entity financial statements prepared for Canadian tax purposes.  Applying a XXXXXXXXXX exchange rate to the data above, USD purchases comprise XXXXXXXXXX% of total purchases, being XXXXXXXXXX purchases. 

18.   While the substantial majority of CanULC’s operating and administrative expenses are incurred in CAD, management estimates that these only represent XXXXXXXXXX% of the total expenses of that company.

19.   At XXXXXXXXXX, XXXXXXXXXX% of CanULC’s CAD$XXXXXXXXXX accounts payable and XXXXXXXXXX% of the CAD$XXXXXXXXXX accounts receivable reported on the CanULC entity financial statements prepared for Canadian tax purposes were denominated in USD.

20.   At XXXXXXXXXX, CanULC’s long-term debt (endnote 1) reported on the CanULC entity financial statements prepared for Canadian tax purposes totalled CAD$XXXXXXXXXX.  XXXXXXXXXX% of this amount was USD denominated debt obligations.

21.   Apart from XXXXXXXXXX transactions in which its shares were issued as consideration for the purchase of shares of other corporations, (endnote 2) CanULC generally (endnote 3) received USD funds as consideration for the issuance of the shares of its capital stock in the past.

Commodity and currency trading activities

22.   CanULC has employees who are skilled and experienced at purchasing and selling Commodities and as a result, CanULC has historically been able to earn a net profit from this activity.  CanULC does not have employees with expertise in trading currencies. 

23.   A-Co has employees who are skilled at managing currency risk and exposure for the Pubco Group, particularly relative to its exposure to USD for financial reporting purposes.

24.   CanULC routinely executes Commodity Contracts with related persons, and other parties with which it deals at arm’s length, to purchase or sell Commodities with delivery subsequent to the date of contract execution.  Although the prices for those Commodities are typically quoted in USD, several of the Commodity Contracts CanULC executes with arm’s length parties provide for settlement in CAD.

25.   In the past, where the settlement currency of its Commodity Contract is CAD, CanULC would generally enter into a Currency Hedging Transaction with A-Co to purchase or sell, in USD, the approximate amount of CAD that it will receive or have to pay on the settlement date of the Commodity Contract. (endnote 4)  CanULC would enter into the Currency Hedging Transaction to minimize the CAD currency exposure given it has the USD as its functional currency for financial reporting purposes.  The exchange rates used for each Currency Hedging Transaction were generally set using publicly quoted future foreign exchange rates prevalent at the time of that Currency Hedging Transaction. 

26.   In the past, where either B-Co1 or B-Co2 entered into a Commodity Contract where the settlement currency was CAD, that corporation would generally enter into a Currency Hedging Transaction with CanULC to purchase or sell, in USD, the approximate amount of CAD that it will receive or have to pay on the settlement date of the Commodity Contract.

27.   Upon entering into a Currency Hedging Transaction with either B-Co1 or B-Co2, CanULC would generally enter into a Back-to-Back Currency Hedging Transaction with A-Co to purchase or sell, in USD, the approximate amount of CAD that it will receive or have to pay on the settlement date of the Currency Hedging Transaction with either B-Co1 or B-Co2, thereby offsetting the CAD exposure assumed by CanULC under the Currency Hedging Transaction described in paragraph 26.

28.   Management of the Pubco Group previously determined that the currency hedging process described in paragraphs 26 and 27 was the most efficient manner available to minimize CAD currency exposure within B-Co1 and B-Co2. (endnote 5)

29.   CanULC has never filed an election pursuant to subsection 261(3).

30.   CanULC does not meet the definitions of “investment corporation”, “mortgage investment corporation” or “mutual fund corporation” as those terms are defined in the Act.

PROPOSED TRANSACTIONS

31.   CanULC will file an election pursuant to subsection 261(3) in the prescribed form and manner on or before XXXXXXXXXX, to report its Canadian tax results in USD for the taxation year that commenced on XXXXXXXXXX.

Subsequent to filing the subsection 261(3) functional currency election:

32.   The Existing Currency Hedging Transactions and Existing Back-to-Back Currency Hedging Transactions of CanULC will close pursuant to the terms and conditions in each underlying contract at some time on or after the Transition Day.

33.   CanULC will continue to enter into Commodity Contracts with related persons and other parties with which it deals at arm’s length in the ordinary course of its business in Canada.  A portion of these Commodity Contracts with arm’s length parties will specify that settlement is to be made in CAD.

34.   In respect of its Commodity Contracts to be settled in CAD, CanULC will enter into Future Currency Hedging Transactions with A-Co to purchase or sell, in USD, the approximate amount of CAD that it will have to pay or will receive on the settlement date of the Commodity Contracts.  The exchange rate used for each Future Currency Hedging Transaction will be set using publicly quoted future foreign exchange rates prevalent at the time of that Future Currency Hedging Transaction.

35.   In respect of their Commodity Contracts to be settled in CAD, B-Co1 and B-Co2 will enter into Future Currency Hedging Transactions with CanULC to purchase or sell, in USD, the approximate amount of CAD that it will have to pay or will receive on the settlement date of the Commodity Contracts that will be settled in CAD.  The exchange rate used for each Future Currency Hedging Transaction will be set using publicly quoted future foreign exchange rates prevalent at the time of that Future Currency Hedging Transaction.

36.   In respect of the Future Currency Hedging Transactions described in paragraph 35, CanULC will enter into Future Back-to-Back Currency Hedging Transactions with A-Co to purchase or sell, in USD, the same amount of CAD that it will have to pay or will receive on the settlement date of the Future Currency Hedging Transactions it enters into with B-Co1 and B-Co2.  The exchange rates used for the Future Back-to-Back Currency Hedging Transactions with A-Co will be identical to the rates used in the related Future Currency Hedging Transactions between CanULC and B-Co1 or B-Co2 for which they are intended to offset.

PURPOSE OF THE PROPOSED TRANSACTIONS

37.   The purpose of filing the subsection 261(3) functional currency election is to allow CanULC to report its Canadian tax results in USD, the primary transactional currency for CanULC and the primary currency in which its financial records are maintained and its financial results are reported.  This will allow CanULC (and therefore Pubco) to minimize the Canadian tax impact of foreign currency fluctuations on reported financial results that currently arise from determining Canadian tax results in a currency which is different than the USD financial reporting currency.

38.   The sole purpose for CanULC entering into the Currency Hedging Transactions with A-Co described in paragraphs 25 and 34 is to minimize the effect of currency fluctuations on its USD reported income where it has Commodity Contracts to be settled in CAD.

39.   The sole purpose for CanULC entering into the Currency Hedging Transactions with B-Co1 and B-Co2 described in paragraphs 26 and 35, together with the corresponding Back-to-Back Currency Hedging Transactions with A-Co described in paragraphs 27 and 36, is to facilitate the ability of B-Co1 and B-Co2 to minimize the effect of currency fluctuations on their USD reported income where they have Commodity Contracts to be settled in CAD.

RULINGS REQUESTED

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and provided further that the proposed transactions are carried out as described above, our Rulings are as follows:

We confirm that:

A.    Subsection 261(5) will apply to CanULC in respect of its taxation year beginning on XXXXXXXXXX, provided that USD remains the primary currency in which CanULC maintains its records and books of account for financial reporting purposes throughout that taxation year;

B.    For the purposes of determining CanULC's income, gain or loss in respect of its Existing Currency Hedging Transactions with A-Co, B-Co1 and B-Co2, subsection 261(21) will not apply to deem each fluctuation in value referred to in paragraph 261(20)(c) not to have occurred;

C.    For the purposes of determining CanULC's income, gain or loss in respect of its Future Currency Hedging Transactions with A-Co, B-Co1 and B-Co2, subsection 261(21) will not apply to deem each fluctuation in value referred to in paragraph 261(20)(c) not to have occurred;

D.    For the purposes of determining CanULC's income, gain or loss in respect of its Existing Back-to-Back Currency Hedging Transactions with A-Co, subsection 261(21) will not apply to deem each fluctuation in value referred to in paragraph 261(20)(c) not to have occurred; and

E.    For the purposes of determining CanULC's income, gain or loss in respect of its Future Back-to-Back Currency Hedging Transactions with A-Co, subsection 261(21) will not apply to deem each fluctuation in value referred to in paragraph 261(20)(c) not to have occurred.

COMMENTS

Nothing in this Advance Income Tax Ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of any tax consequences relating to the Facts, Proposed Transactions and Purpose of the Proposed Transactions described herein other than that specifically described in the rulings given above.

Without limiting the generality of the foregoing, nothing in this Advance Income Tax Ruling should be construed as implying that the CRA has considered or is giving an opinion on whether the terms of the Currency Hedging Transactions and Back-to-Back Currency Hedging Transactions discussed in paragraphs 32 and 34 through 36 will reflect arm’s length terms.

The Rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R6 and are binding on the CRA provided that the proposed transaction in paragraph 31 is completed on or before XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

ENDNOTES

1  Long-term debt includes the carrying amount of all long-term obligations on the balance sheet, excluding deferred revenue and reserves for future obligations.
2  Transactions involving the application of subsection 85(1).
3  Except for a nominal amount of CAD received upon the initial incorporation of CanULC.
4  Rather than immediately enter into a Currency Hedging Transaction in respect of CAD resulting from smaller Commodity Contracts, such smaller amounts of CAD have generally been aggregated (and offset against other CAD transactions of similar amount and same duration arising on the same day with arm’s length parties) until management considered the aggregate currency exposure within CanULC to be significant, whereupon CanULC entered into a Currency Hedging Transaction with A-Co to purchase or sell, in USD, the net aggregate amount of CAD resulting from the smaller Commodity Contracts.
5  B-Co1 and B-Co2 are currently re-evaluating this process.  At some date prior to XXXXXXXXXX, it is expected that B-Co1 and B-Co2 will hedge their respective CAD exposure by entering into Currency Hedging Transactions directly with A-Co, as opposed to the back-to-back transactions through CanULC as described in paragraphs 26 and 27.

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