Canada: Foreign exchange gains and losses from forward contracts

Carrie Aiken		Dan Jankovic

The Tax Court of Canada in George Weston Limited v R (2015 TCC 42) recently held that an early termination of a currency swap entered into by a Canadian public corporation (GWL) with substantial (indirect) US operations to hedge foreign currency fluctuations and their impact on its consolidated financial statements resulted in a capital gain. The decision rejects outright the Canada Revenue Agency's administrative position that a derivative transaction is on capital account only if the transaction is a hedge that is sufficiently linked to an underlying transaction on capital account (for example, a sale of an asset or repayment of debt) and not an asset or liability and further, that the hedge must be undertaken by the entity that directly owns the item being hedged.

GWL entered into the swaps shortly after a large acquisition of a US business by one of its subsidiaries. The scale of the US operations and the fluctuations in the Canada-US dollar exchange rate had significant impact on GWL's Canadian dollar consolidated financial statements, affecting its debt-to-equity ratio, borrowing capacity and credit rating.

In characterising the swaps, the Court emphasised that it is important to identify the risk to which the transaction relates and determine whether the item at risk (whether a debt obligation or foreign investment) is capital or income in nature. GWL's intention was to hedge its US investment (which was on capital account) and protect against currency risk that impacted its capital structure. Absent the investment, GWL would not have entered into the swaps since it did not, as a matter of policy, generally participate in derivatives. The Court concluded that the swap was sufficiently linked to GWL's indirect capital investment and was intended to hedge the associated currency risk even though there was no contemplated sale of the investment at the time the swap was entered into. The fact that the swaps were terminated when the taxpayer decided it was no longer necessary to hedge such foreign currency risk did not alter that conclusion.

Taxpayers may want to revisit their characterisation of hedging transactions for Canadian tax purposes in light of this decision.

Carrie Aiken (carrie.aiken@blakes.com) and Daniel Jankovic (dan.jankovic@blakes.com), Calgary
Blake, Cassels & Graydon
Tel: +1 403 260 9775 and +1 403 260 9725
Website: www.blakes.com

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