CIBC v. The King, 2023 FCA 91.

• Jurisdiction: United States,Federal
• Law Firm: McCarthy Tétrault LLP
• Subject Matter: Tax, Income Tax, Capital Gains Tax
• Author: Mr Leonard Nesbitt and Kathryn Walker
• Published date: 18 September 2023

Introduction

On May 4, 2023, the Federal Court of Appeal ("FCA") released its judgement¹ dismissing an appeal by Canadian Imperial Bank of Commerce ("CIBC") from a Tax Court of Canada ("TCC") decision² regarding the interaction of subsections 39(2)³ and 40(3.6) of the Income Tax Act (Canada)⁴ (the "ITA")⁵ in the context of a loss realized by CIBC in September, 2007 on the redemption of U.S. dollar-denominated shares it held in CIBC Delaware Holdings Inc. ("DHI"). The loss was solely attributable to the fluctuation in the value of the U.S. dollar ("US$") relative to the Canadian dollar ("C$") over the period in which CIBC held the shares of DHI.

While CIBC FCA concerned a historic version of subsection 39(2), the case raises an issue of potential significance to Canadian capital markets. As the Supreme Court of Canada has observed: "Canadian capital markets are of relatively modest size, and it is common for corporations requiring significant amounts of capital to look elsewhere in the world for financing."⁶ Canada's economy relies on access to foreign capital,⁷ and therefore the tax rules governing the treatment of foreign exchange gains and losses to a Canadian corporate issuer of debt in foreign markets must be clear.

The FCA's decision may arguably be viewed as introducing uncertainty Fregarding the application of both the historic version of subsection 39(2) and Amended Subsection 39(2). Specifically, the FCA held that subsection 39(2) cannot apply in and of itself to determine the amount of gains made or losses sustained because of foreign currency fluctuation on the disposition of shares. Such determination must first be made under separate provisions of the ITA. On its face, the decision is not strictly confined to the application of historic subsection 39(2) in the context of a disposition of property. Amended Subsection 39(2), which is limited to the settlement of foreign currency denominated debt, still contains the key words "made a gain or sustained a loss" that were considered in the FCA in interpreting historic subsection 39(2). However, the approach of first determining the amount of a gain made or loss sustained under a different provision of the ITA (i.e., section 40) before applying Amended Subsection 39(2) does not work on the settlement of debt. The settlement of debt is not a disposition of property by the issuer. The FCA did not address this distinction and, as a result, the decision may arguably be seen as introducing uncertainty regarding the recognition of foreign exchange gains and losses to Canadian issuers of foreign currency denominated debt.

The main issue in CIBC FCA was whether subsection 39(2) applied to deem CIBC's foreign currency related loss to be a capital loss from the disposition of foreign currency before the application of paragraph 40(3.6)(a), which would deem the loss from the redemption of the shares by DHI to be nil. CIBC argued that, consistent with the FCA's decision in Bank of Montreal,⁸ subsection 39(2) applied to deem the loss to be a capital loss from the disposition of foreign currency, and, therefore, there was no loss from the redemption of the shares to which 40(3.6) could apply.

In BMO, the FCA held that subsection 39(2) applied before subsection 112(3.1)⁹ in the context of a loss realized on the disposition in 2010 of US$-denominated common shares of a Nova Scotia unlimited liability company ("NSULC") by a limited partnership of which BMO was a limited partner. The Minister had reassessed Bank of Montreal ("BMO") under the general anti-avoidance rule ("GAAR") on the basis that BMO had avoided the application of subsection 112(3.1) by creating a class of preferred shares of NSULC on which dividends were paid. In dismissing the Crown's appeal, the FCA affirmed that subsection 39(2) could apply to foreign exchange losses arising from a disposition of property and held that subsection 39(2) applied to deem BMO's loss to be from a disposition of foreign currency. As such, there was no loss from the disposition of the shares to which subsection 112(3.1) could apply.

Seemingly at odds with the outcome in BMO, the TCC in CIBC TCC found that subsection 40(3.6) applied in priority to subsection 39(2) to deem CIBC's loss from the disposition of the shares of DHI to be nil. As such, there was no scope for the application of subsection 39(2). In CIBC FCA, the FCA dismissed CIBC's appeal, holding that the TCC did not err in its decision. Webb J.A. delivered the reasons for judgement on behalf of the FCA.

The decision in CIBC FCA raises significant interpretive issues involving the foreign currency fluctuation regime in subsection 39(2) and its interaction with other provisions in Subdivision c of Division B ("Subdivision C") of Part I of the ITA among others. One interpretative issue concerns the relationship between the different stop-loss rules (subsection 112(3.1) in BMO and subsection 40(3.6) in CIBC FCA) and subsection 39(2). A second interpretive issue concerns the words "sustained a loss" in subsection 39(2). In CIBC FCA the words were interpreted as requiring a loss to first be determined under other provisions of Subdivision C, namely section 40. Such interpretation implies that subsection 39(2) does not operate as a stand-alone provision and that other provisions that compute a taxpayer's gain or loss under section 40 take precedence.

We discuss and consider aspects of the FCA's reasoning in CIBC FCA in the context of the interpretive issues noted above. We start with a discussion of the relevant judicial history in the BMO and CIBC cases.

Judicial History: BMO and CIBC

BMO

BMO concerned the operation of subsection 39(2) in combination with subsection 112(3.1). The facts of the case are that BMO implemented an equity financing structure to fund certain U.S. subsidiaries. BMO became a partner in a Nevada limited partnership ("NLP") that acquired US$-denominated common shares and preferred shares of NSULC.

In order to hedge against certain currency fluctuation risks, the structure was organized such that dividends were paid on the preferred shares. The case was brought under the GAAR, with a key issue being whether the use of the preferred shares created a tax benefit. BMO argued, successfully at both the TCC and the FCA that there was no benefit on the basis that due to the operation of subsection 39(2), subsection 112(3.1) did not apply, such that the use of preferred shares to avoid subsection 112(3.1) was irrelevant and produced no tax benefit.

The TCC decision was concerned largely with the interpretation of subsection 39(2) and, in particular, whether the provision should be interpreted as applying exclusively to gains or losses arising on settlement of obligations on capital account or, more broadly, as applying to gains or losses arising from dispositions of any kind of property as well as on the settlement of obligations on capital account. The TCC found in favour of the latter interpretation (referred to as the "broad interpretation").

On appeal, the...