Foreign Currency Considerations in Tax Law and Policy

By Akbari, Sina | University of Toronto Faculty of Law Review, Winter 2008 | Go to article overview
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Foreign Currency Considerations in Tax Law and Policy


Akbari, Sina, University of Toronto Faculty of Law Review


I INTRODUCTION

II NORMATIVE LENS OF ECONOMIC EFFICIENCY

III ANALYTICAL FRAMEWORK & THE ECONOMICS OF FOREIGN
CURRENCY EXCHANGE
  Two-Step Analytical Framework
  The Economics of Future Currency Exchange Rates
  Discount Bonds: An Analogy
  Summary of the Economics of Foreign Exchange Gains and Losses

IV THE CURRENT STATE OF CANADIAN TAX LAW
  Purchase of Inventory in Foreign Currency
  Disposition of Capital Valued in Foreign Currency
  Foreign Currency Debt Redemption
  Treatment of Futures Contracts and Hedging
  Subsection 39(2): The Residual Treatment of Foreign Currency Gains
    or Losses

V ECONOMIC ANALYSIS OF INCENTIVES CREATED BY THE CURRENT
LEGAL REGIME
  Purchase of Inventory in Foreign Currency
  Disposition of Capital Valued in Foreign Currency
  Foreign Currency Debt Redemption
  Treatment of Futures Contracts and Hedging

VI PROPOSED POLICY FRAMEWORK

Abstract

This article examines the Canadian tax jurisprudence and statutory regime relating to foreign currency transactions and critically analyzes the systematic incentives created by the law through the normative framework of economic neutrality. Canadian tax law has approached the treatment of foreign currency transactions on an inconsistent and piecemeal basis. Historically, the courts have applied general rules such as the surrogatum principle or the test in Gaynor v. Minister of National Revenue without a principled justification for their use. The legislature has responded to discrete issues as they arise, failing to adopt a general statutory framework dealing with the issue as a whole.

By focusing on the economic substance of foreign currency movements as explained by the interest rate parity relationship, this article attempts to articulate a tax policy framework that is internally coherent, consistent with the general scheme of the Income Tax Act, and minimally distortionary. First, the author argues that a currency-related gain or loss must be analyzed separate and apart from its underlying transaction. Second, foreign currency gains or losses must be analyzed in terms of two distinct types of gains or losses. The first relates to an expected gain or loss that can be described by the current interest rate environment and the interest rate parity. The second is an unexpected gain or loss that is explained by changes which occur subsequent to the entering into of a transaction. Finally, the author argues that expected gains or losses should be fully taxable as income or deductible as losses and that unexpected gains or losses should be treated on capital account.

Resume

Cet article examine la jurisprudence fiscale canadienne et le regime statutaire lie aux operations en monnaies etrangeres et fait une analyse critique de l'incitative systematique creee par la loi en utilisant le cadre normatif de la neutralite economique. Le droit fiscal canadien a aborde la question du traitement d'operations en monnaies etrangeres d'une maniere fragmentaire et incoherente. Au niveau historique, les tribunaux ont applique des regles generales, comme le principe <> ou le test propose dans Gaynor v. le Ministre du Revenu national sans justifier leur raisonnement. La legislature a repondu aux questions concretes lorsque qu'elles se sont presentees, mais n'a pas adopte une reponse legislative generale pour completement resoudre le probleme.

En se concentrant sur la realite economique des mouvements en monnaies etrangeres, expliquee par le partenariat de parite des taux d'interet, cet article essaye d'articuler une politique fiscale qui est coherente, uniforme au plan general de la Loi de l'impot sur le revenu, et qui cause le moins de distorsions possible. Premierement, l'auteur avance qu'une perte ou un profit lie a l'unite monetaire doit etre analyse separement de sa transaction sous-jacente. Deuxiemement, les pertes ou les gains lies a l'unite monetaire doivent etre analyses avec deux types de pertes ou de gains distincts.

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