23 May 2013 Roundtable Q. , 2013-0486741C6

Principal Issues: Does the GAAR apply to a series of transactions undertaken for the purpose of avoiding the application of subsection 93(2) so as to preserve the portion of a loss on the disposition of FA shares that is attributable to foreign exchange, such that it remains available to effectively offset a foreign exchange gain related to the investment in the FA shares?

Position: Yes, unless the gain sought to be offset is a gain described in proposed subparagraph 93(2.01)(b)(ii).

Reasons: Parliament has specified precisely which related foreign exchange gains realized by a taxpayer are intended to affect the computation of the amount of the loss to be denied on the disposition of FA shares.

IFA Roundtable, May 2013

Question 3: GAAR and Subsection 93(2)

Subsection 93(2) generally applies to deny a loss on the disposition of a share of a foreign affiliate (an "FA") to the extent that exempt dividends had been received on that share, or on a share for which that share had been substituted, prior to the disposition.

What is the CRA's position on the application of the GAAR to a series of transactions undertaken for the purpose of avoiding the application of subsection 93(2) so as to preserve the portion of a loss on the disposition of FA shares that is attributable to foreign exchange, such that it remains available to effectively offset a foreign exchange gain related to the investment in the FA shares?

Response:

It is our view that the GAAR would apply to a series of transactions undertaken by a taxpayer primarily for the purpose of avoiding the application of subsection 93(2), including in those circumstances where the otherwise denied foreign exchange loss on the disposition of FA shares would effectively offset what the taxpayer views as a foreign exchange gain on a related debt or hedging instrument, unless that foreign exchange gain is a gain described in proposed subparagraph 93(2.01)(b)(ii).

Parliament has, in proposed subparagraph 93(2.01)(b)(ii), specified precisely which related foreign exchange gains realized by a taxpayer are intended to affect the computation of the amount of the loss to be denied on the disposition of an FA share. Therefore, it is our view that except in circumstances described in proposed subparagraph 93(2.01)(b)(ii), subsection 93(2) and proposed subsection 93(2.01) are intended to deny a loss on the disposition of an FA share to the extent that exempt dividends had been received on that share, or on a share for which that share had been substituted, prior to the disposition, even in circumstances where the loss is arguably due to foreign exchange fluctuations rather than the extraction of earnings from the FA.

Consider a case where a corporation resident in Canada ("Canco") borrows U.S. dollars from a related party and uses them to acquire common shares of an FA carrying on an active business in the United States. Over a number of years, FA's business activities result in a large exempt surplus balance. During the same period, a large foreign exchange gain accrues on Canco's U.S. dollar denominated debt. In contemplation of the sale of the FA common shares and repayment of the debt, Canco acquires preferred shares of FA for nominal consideration. The exempt earnings of FA are distributed to Canco on the preferred shares. Canco then disposes of the FA common shares realizing a loss. A foreign exchange gain is realized on the repayment of the debt and the two are offset.

In this example, the issuance of the FA preferred shares and the payment of dividends thereon are avoidance transactions carried out for the purpose of avoiding subsection 93(2). Moreover, since a foreign exchange gain realized on the repayment of a non-arm's-length debt is not a gain described in proposed subparagraph 93(2.01)(b)(ii), it was not intended that it should affect the computation of the loss denied under subsection 93(2). Therefore the issuance of the FA preferred shares and the payment of the dividends thereon result in an abuse having regard to subsection 93(2) such that the GAAR would apply. Our opinion would be the same if, for the purpose of avoiding the application of subsection 93(2), the preferred shares were issued on the initial incorporation of the FA.

We would note that the denial of a loss on the disposition of FA shares while taxing a related foreign exchange gain is, in our view, not inconsistent with the provisions of the Act read as a whole. To conclude otherwise would require the CRA to search for an overriding policy in the Act which provides for the offsetting of gains and losses which are in some way linked. A unified, textual, contextual and purposive interpretation of specific provisions of the Act does not, in our view, reveal such an overarching policy.

Lori Carruthers
2013-048674