2021-0911941C6 261(21), Loan to FA and Excluded Property

Principal Issues: Whether subsection 261(21) applies to deny a foreign exchange loss realized by a Canadian-resident corporation (“Parent”) on the settlement of a loan (“Parent-FA Loan”) to a foreign affiliate (“FA”) of a related Canadian-resident corporation, where any gain of FA that would be derived from the settlement of the loan would be deemed to be a gain from the disposition of an excluded property of FA.

Position: No.

Reasons: Since any gain of FA that would be derived from the settlement of the Parent-FA Loan would be deemed to be a gain from the disposition of an excluded property and FA does not have, in the scenario provided, any Canadian tax results, and therefore has no tax reporting currency during the accrual period, Parent and FA are not considered to have different tax reporting currencies for the purposes of paragraph 261(20)(b). As such, the conditions for the application of subsection 261(21) are not satisfied.

Author: Dion, Jean-Bernard
Section: Subsections 260(6.1), (20) and (21).

2021 CTF Annual Tax Conference
CRA Roundtable

Question 11 – 261(21), Loan to FA and Excluded Property

In response to question 4 of the 2017 IFA tax conference, the CRA commented on the application of subsections 261(20) and (21) (published in CRA document 2017-0691211C6). In the scenario discussed, the following were the relevant assumed facts:

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

2. Cansub is a Canadian-resident corporation and a wholly-owned subsidiary of Parent. Cansub has made a functional currency election to use the USD as its functional currency for Canadian income tax purposes.

3. 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.

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

5. The FA-Parent Loan is not an “excluded property” (as defined in subsection 95(1)) of FA.

6. Parent realizes a foreign exchange loss on the repayment of the FA-Parent Loan, and an offsetting foreign exchange gain on the settlement of the Hedge.

In its response, the CRA indicated that subsection 261(21) applies in respect of a “specified transaction”, which in this scenario was the FA-Parent Loan. Further, the CRA’s analysis was that subsection 261(6.1) provides that, for the purposes of determining FA’s foreign accrual property income (“FAPI”) (as defined in subsection 95(1)) 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. Based on the loan giving rise to FAPI and the context of subsection 261(6.1), subsection 261(21) applied to the upstream loan.

If the facts were changed such that the “specified transaction” was instead a loan from Parent to FA (“Parent-FA Loan”) and that the gain or loss that is derived from the settlement of this loan was deemed, pursuant to paragraph 95(2)(i), to be a gain or loss from the disposition of an excluded property of FA (not giving rise to FAPI), does the CRA agree that subsection 261(21) should not apply in respect of the Parent-FA Loan?

CRA Response

Subsection 261(20) states that subsection 261(21) applies in determining a taxpayer's income, gain or loss for a taxation year in respect of a transaction (a “specified transaction”) if:

a) the specified transaction was entered into, directly or indirectly, at any time by the taxpayer and a related corporation (paragraph 261(20)(a));

b) the taxpayer and the related corporation had different tax reporting currencies at any time during the period (the “accrual period”) in which the income, gain or loss accrued (paragraph 261(20)(b)); and

c) in the absence of subsections 261(20) and (21), it would be reasonable to consider that a fluctuation at any time in the accrual period in the value of the taxpayer's tax reporting currency relative to the value of the related corporation's tax reporting currency increased the taxpayer's loss in respect of the specified transaction, reduced the taxpayer's income or gain in respect of the specified transaction, or caused the taxpayer to have a loss, instead of income or a gain, in respect of the specified transaction (paragraph 261(20)(c)).

If subsection 261(21) applies, each fluctuation in value referred to above is deemed not to have occurred, notwithstanding any other provision of the Act.

Having regard to the hypothetical scenario described in the question, pursuant to the condition in paragraph 261(20)(b), it must be determined whether Parent and FA have different tax reporting currencies at any time during the period in which Parent’s foreign exchange loss in respect of the Parent-FA Loan accrued.

On the one hand, since Parent did not make a functional currency election under subsection 261(3), subsection 261(2) provides that its tax reporting currency is the Canadian dollar.

On the other hand, contrary to the scenario discussed in response to question 4 of the CRA round table at the 2017 IFA tax conference, in this question, the amount of any foreign exchange gain or loss realized by FA that would be derived from the settlement of the Parent-FA Loan would be deemed to be a gain or loss from the disposition of an excluded property and, as such, would not constitute an amount that enters in the determination of FA’s FAPI in respect of Cansub.

Given that no FAPI results from the Parent-FA Loan and considering that FA does not have Canadian tax results for the taxation years in which the accrual period occurs, we are of the view that FA would not have a “tax reporting currency”, as that term is defined under subsection 261(1), during the accrual period.

Therefore, for the purposes of paragraph 261(20)(b), Parent and FA do not have different tax reporting currencies during the accrual period. Since the condition set out in paragraph 261(20)(b) is not satisfied in the scenario described above, subsection 261(21) does not apply to deny the foreign exchange loss realized by Parent from the settlement of the Parent-FA Loan.

This response turns on the specific facts and assumptions outlined above. We recommend that an advance income tax ruling be requested to confirm the application of the relevant provisions where other circumstances exist.

Jean-Bernard Dion
2021-091194
November 25, 2021

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