2017-0691211C6 IFA 2017 Q.4: App of s. 261(21) to loan with FA

Principal Issues: Would subsection 261(21) apply to deny foreign exchange loss of CAD reporting Canadian-resident corporation realized on settlement of loan from foreign affiliate of related Canadian-resident corporation.

Position: Yes

Reasons: In respect of the “specified transaction" under subsections 261(20) and (21), i.e., the loan, the FA's tax reporting currency is USD. Therefore the condition in paragraph 261(20)(b) that the taxpayers have different tax reporting currencies will be met.

Author: Johns, Jeffrey
Section: 261(6.1), 261(20), 261(21)

2017 International Fiscal Association Conference

CRA Roundtable

Question 4 – Subsections 261(20) / (21) and foreign affiliates

If the conditions set out in subsection 261(20) are satisfied, subsection 261(21) provides that, for purposes of determining a taxpayer’s income, gain or loss in respect of a “specified transaction”, certain fluctuations in the relative values of the taxpayer’s “tax reporting currency” and the tax reporting currency of a related taxpayer are deemed not to have occurred. In general, these conditions require that the specified transaction be entered into between related taxpayers with different tax reporting currencies during the period in which the income, gain or loss accrued and that, in the absence of these provisions, it would be reasonable to consider that such a fluctuation either increased the taxpayer’s loss, reduced the taxpayer’s income or gain, or caused the taxpayer to have a loss instead of income or gain in respect of the specified transaction.

Subsection 261(1) defines “tax reporting currency” to mean the currency in which a taxpayer’s “Canadian tax results” are determined, and the definition of “Canadian tax results” in that same subsection includes any amount that is relevant in computing income, taxable income, or taxable income earned in Canada of the taxpayer.

Assume the following facts:

*     Parent is a Canadian-resident corporation and the parent corporation of a multinational group. Parent computes its Canadian tax results in Canadian dollars.

*     Cansub is a Canadian-resident corporation and a wholly-owned subsidiary of Parent.   Cansub has made a functional currency election to use U.S. dollars (“USD”) as its functional currency for Canadian income tax purposes.

*     FA is a corporation resident in the U.S. and a wholly-owned subsidiary of Cansub. FA carries on an active business in the U.S. and uses USD as its “calculating currency” for purposes of the Canadian foreign affiliate rules.  

*     FA makes an upstream loan to Parent (“FA-Parent Loan”) denominated in USD. Parent enters into a third party hedging arrangement (“Hedge”) in order to hedge its foreign exchange exposure on the FA-Parent Loan.

*     Parent realizes a foreign exchange loss (“Foreign Exchange Loss”) on the repayment of the FA-Parent Loan, and an offsetting foreign exchange gain (“Foreign Exchange Gain”) on the settlement of the Hedge. 

Subsection 261(6.1) deems a foreign affiliate of a taxpayer, for purposes of computing the foreign affiliate’s foreign accrual property income (“FAPI”) in respect of that taxpayer, to have an “elected functional currency” that is the same as the elected functional currency of that taxpayer. 

If Parent had realized a foreign exchange gain on the repayment of the FA-Parent Loan, that gain would have been offset by a foreign exchange loss on the settlement of the Hedge, and Parent would have achieved its purpose of hedging its foreign exchange exposure. However, if subsections 261(20) and (21) operate to deny the Foreign Exchange Loss on the repayment of the FA-Parent Loan, the purpose of the Hedge would be frustrated as the Foreign Exchange Gain on its settlement would not be offset with the Foreign Exchange Loss.

Does the CRA agree that the condition in paragraph 261(20)(b) would not be met in this example such that subsection 261(21) would not apply to deny the Foreign Exchange Loss, because FA is deemed to have an elected functional currency only for purposes of determining its FAPI, and not for purposes of applying subsection 261(21) to the Foreign Exchange Loss?

CRA Response

Subsection 261(21) applies in respect of a “specified transaction”. The determination of whether the conditions in subsection 261(20) are met must be made in that context. In this example, the specified transaction for the purposes of determining the application of subsection 261(21) is the FA-Parent Loan. Therefore, the application of the conditions in subsection 261(20) must be determined in respect of that loan. Please note that our comments assume the FA-Parent Loan is on capital account in respect of Parent and FA.

The condition in paragraph 261(20)(b) will be satisfied if Parent and FA have different tax reporting currencies at any time during which Parent’s loss in respect of the FA-Parent Loan accrued. Pursuant to its definition in subsection 261(1), the determination of a taxpayer’s tax reporting currency is made by examining the currency in which the taxpayer itself determines its Canadian tax results under the Act. Therefore, in order to determine whether the condition in paragraph 261(20)(b) is met, it must be separately determined:

a.    in which currency the Act requires Parent to compute its Canadian tax results, and

b.    in which currency the Act requires FA to determine its Canadian tax results.

As Parent has not made a functional currency election under subsection 261(3), subsection 261(2) requires that it determine its Canadian tax results in Canadian dollars and, thus, its tax reporting currency is Canadian dollars.

With respect to FA, subsection 261(6.1) provides that, for the purposes of determining FA’s FAPI in respect of Cansub:

*     FA is deemed to have elected to determine its Canadian tax results in USD, and

*     FA’s Canadian tax results are its FAPI in respect of Cansub, and any amount relevant to that determination. 

Therefore, FA’s tax reporting currency under the Act in respect of any amount relevant to FA’s FAPI in respect of Cansub will be USD.

As the FA-Parent Loan is not “excluded property” (as defined in subsection 95(1)) of FA, any gain or loss realized by FA on the settlement of the loan would be relevant to the determination of FA’s FAPI in respect of Cansub. Consequently, FA’s tax reporting currency in respect of the FA-Parent Loan is USD.

As FA and Parent will have different tax reporting currencies during the period Parent’s loss in respect of the FA-Parent Loan accrued, we would consider the condition in paragraph 261(20)(b) to be met, and subsection 261(21) to be applicable.

In the CRA’s view, this result is consistent with the policy underlying subsections 261(20) and (21). In particular, it should be noted that subsection 261(21) would have applied to deny any loss of FA in respect of the FA-Parent Loan in computing its FAPI in respect of Cansub had the loan been denominated in Canadian dollars.

Jeffrey Johns
Terry Young
2017-069121
April 26, 2017

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