New And Improved Functional Currency Proposals - Tax Topics

On November 10, 2008, the Department of Finance released draft

legislation to amend the recently enacted functional currency rules

in section 261 of the Income Tax Act (Canada) (the

''Act''). The proposed amendments follow from the

Finance press release of June 27, 2008, which first announced the

most significant of the intended changes. Among other things, that

press release extended the first deadline for electing into the

functional currency regime to October 31, 2008 for taxation years

of Canadian corporations beginning after December 13, 2007. In an

October 29, 2008 press release, that deadline was further extended

to December 15, 2008. The new draft legislation incorporates this

initial extended election deadline, adopts the changes first

announced on June 27, 2008, and implements numerous other

modifications to the functional currency regime in the course of

completely rewriting section 261.

This article reviews the key changes to the functional currency

regime proposed in the draft legislation, and describes in

high-level terms the operation of the new overhauled rules. The

draft legislation proposes a comprehensive replacement of section

261, and the accompanying Finance explanatory notes (the

''Explanatory Notes'') provide quite a helpful

description of the many changes. This article therefore highlights

only the more significant changes to build on the commentary in the

Explanatory Notes. New aspects of the proposed functional currency

rules that deal with their application to partnerships and to

''reversionary years'' of taxpayers that exit from

the functional currency regime are noted, but not discussed.

Overview Of The Revised Functional Currency Rules

All taxpayers are subject to subsection 261(2), which requires

that Canadian currency be used to determine the Canadian tax

results of a taxpayer, unless the taxpayer is a Canadian resident

corporation that has elected instead to determine its Canadian tax

results using a qualifying functional currency. The Canadian tax

results that are to be determined in either Canadian currency or a

functional currency are the computations of a taxpayer's

income, taxable income, taxable income earned in Canada, tax or

other amounts payable by or refundable to the taxpayer, and any

amounts relevant in determining such amounts — in other

words, every computation that matters for tax purposes.

The general rule in subsection 261(2) clarifies that, for most

purposes of the Act, where a taxpayer...