Canada: Canada introduces debt-parking rules to prevent avoidance of foreign exchange gains
Canada's Department of Finance has published proposals that would implement anti-avoidance measures when borrowers enter into "debt-parking" transactions that may result in a foreign exchange gain when the foreign currency is exchanged into Canadian dollars for tax reporting purposes.
Kevin P Zimka
Under Canada's Income Tax Act (the Act) all amounts relevant to the computation of income generally must be reported in Canadian dollars. If an amount is denominated in a foreign currency, the Act requires it to be converted into Canadian dollars. Pursuant to subsection 39(2) of the Act, a borrower may realise a capital gain or capital loss on the repayment of a debt denominated in a foreign currency as a result of fluctuation in the value of the foreign currency against the Canadian dollar.
To avoid realising a foreign exchange gain on repayment of debt denominated in a foreign currency, some borrowers have entered into "debt-parking" transactions. These transactions involve the borrower arranging for a person, with whom the borrower does not deal at arm's length, to acquire the debt from a third party creditor for a purchase price equal to the principal amount rather than the borrower repaying the debt. From the third-party creditor's perspective the debt is effectively repaid, but from the borrower's perspective the debt remains owing and no foreign exchange gain is realised.
On July 29 2016, the Department of Finance released legislative proposals to amend the Act so that accrued foreign exchange gains on a foreign currency denominated debt would be realised when such debt becomes a "parked obligation".
The legislative proposals deem the borrower to have made, at the time the debt becomes a "parked obligation", the capital gain that the borrower otherwise would have made if it had paid an amount at that time in satisfaction of the debt equal to:
1) The price paid to purchase the debt at that time; or
2) If the debt is not purchased at that time, the fair market value of the debt at that time.
In order to be a "parked obligation", the legislative proposals require that both:
i) At the particular time, the holder of the debt does not deal at arm's length with the borrower or where the borrower is a corporation, has a "significant interest" in the borrower; and
ii) At any previous time, a person who held the debt dealt at arm's length with the borrower and, where the borrower is a corporation, did not have a significant interest in the borrower.
Further, one of the main purposes of the transaction that resulted in the debt meeting the condition in (i) above must be to avoid recognition of the foreign exchange gains.
Generally, a person will have a significant interest in the corporation if they or any other person with whom they do not deal at arm's length owns shares of the corporation to which 25% or more of the votes or value are attributable.
This rule was generally effective on March 22 2016, subject to grandfathering for a debt that becomes a parked obligation before 2017 pursuant to a written agreement entered into before March 22 2016.
Taxpayers potentially affected by these rules should consult their tax advisers.
Kevin P Zimka (firstname.lastname@example.org)
Blake, Cassels & Graydon
Tel: +1 604 631 3363