Changes to functional currency rules alleviates confusion and complications

Many mining companies that reside in Canada prepare US dollar financial statements — mainly because the commodities mined are priced in US dollars. As a result, many face numerous tax complexities.

Since these companies often maintain only US dollar books and records, it’s either not possible or cumbersome to accurately measure income for Canadian tax purposes calculated in Canadian dollars. Also, these companies are required to accrue in their quarterly financial statements, future Canadian taxes on accrued foreign exchange gains that arose only because of the requirement to calculate taxable income in Canadian dollars. This result is not reflective of the economic risks that companies assume and it makes it difficult for them to predict their effective tax rate. To alleviate these complexities, the federal government introduced measures in December, 2007, to allow certain companies to compute taxable income in US dollars.*

However, there were a number of technical flaws. The legislation stated that only companies who use the US dollar more often than any other qualify to use the new regime. It wasn’t clear whether a company that has most of its expenses in Canadian dollars would meet this test. Further, companies that did not have subsidiaries might not be allowed to make the election. Finally, the transitional rules for companies that elect in 2008 require a company that had US dollar assets equal to US dollar liabilities to lock in a net foreign exchange gain.

In June, 2008, the Department of Finance issued a news release which proposed measures to provide more certainty around which taxpayers can use the functional currency regime and eliminate the confusion and complications.

Proposed Changes

The Government did not release draft legislation to implement the proposals but did provide a summary of the proposals. As a concession, companies wishing to elect for 2008 now have until October 31, 2008, to make this election.

Definitions

Legislation will be modified to eliminate the requirements that the US dollar was used:

• “more often than” any other in their business, and

• in the corporation’s consolidated financial statements.

The Government has proposed to replace these requirements with a new test that requires the US dollar be the “primary currency in which the corporation maintains its books and records of account for financial reporting purpose.” Since draft legislation to implement these changes was not released, we will have to wait to see how the terms “books and records” and “financial reporting purposes” are defined.

Transitional Exchange Rate

The Government has proposed to revise the transitional rules so that a qualifying company will translate its tax attributes and debt obligations using the exchange rate on the day immediately before the end of the last Canadian currency year. This eliminates the result that a net gain is locked in when a company has equal US dollar assets and liabilities

Reversion to the Canadian dollar

The existing rules do not allow companies to revoke a functional currency election. Only if they cease to meet the functional currency requirements do they revert back to the Canadian dollar. The Government has proposed to allow companies currently in the functional currency regime to elect out of it. The election is due six months before the end of the last functional currency year.

Anti-avoidance rule

The Government expressed concerns that existing rules may be open to abuse, particularly given the election is made on an individual company basis. To deal with the perceived opportunities for abuse, the proposals introduce an anti-avoidance rule that applies when the company that makes a functional currency election has amounts owing to, or from, a company resident in Canada.

The intention of the proposals is to make the rules easier to comply with. It is hoped that the Government will allow a longer period of consultation to permit all stakeholders to comment on the draft legislation to help prevent deficiencies.

For more information visitwww.pwc.com/ca/mining

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* While this article refers to using the US dollar as the calculating currency, the proposals also allow taxable income to be calculated in Euros, British Pounds or Australian dollars.