Currency Reporting Requirements
Section 261 of Income Tax Act generally requires amounts reported on Canadian tax returns and other tax filings be reported in Canadian currency. Taxpayers reporting foreign income or property should utilize the exchange rates reported by the Bank of Canada to convert foreign currency amounts to Canadian currency. The sole exception to this rule applies to corporations resident in Canada who may elect to report in a functional currency.
Residence determines the applicability of Canadian tax law and Canadian taxes to a particular taxpayer. A corporation's residence is determined on one of three grounds; statutorily, common law or by tax treaty, as follows:
- Statutorily: Under subsection 250(4) of the Income Tax Act, any corporation incorporated in Canada after April 26, 1965 is resident in Canada.
- Common Law: Under the common law rules, a corporation is resident of the country where its "central manage and control actually abides" De Beers Consolidated Mines Ltd v. Howe (1906) HL. This will generally be the country in which the board of directors actually make decisions regarding operation of the corporation.
- Tax Treaty: Corporations which are operate in multiple countries, or a different country to where they were incorporated, may find they are consider resident of multiple countries. The "tie breaker" rules in tax treaties exist to deem these corporations resident of only one country party to the treaty.
What is functional currency?
A functional currency, as defined in subsection 261(1) of the Income Tax Act, is one which is both a qualifying currency and is the primary currency in which the taxpayer maintains its records and books for financial reporting. At present, the four qualifying currencies are the U.S. dollar, the Euro, the British pound and the Australian dollar. Whether one of these currencies is considered the corporation's primary currency for financial reporting is a question of fact. In most cases, this will be the currency the corporation uses for financial accounting purposes for its most significant business.
Functional Currency Election
To begin reporting in a functional currency, the corporation must make the functional currency reporting election using the prescribed form. The requirements for this election are found in subsection 261(3) of the Income Tax Act. A corporation must:
- Be resident in Canada throughout the taxation year
- Not be an investment, mortgage investment or mutual fund corporation
- File the prescribed form at least 61 days before the start of the taxation year
- Not have previously filed or revoked a functional currency election
The corporation only needs to file the election once. It will continue to file in its functional currency until it ceases operation, or as described below, revokes or is deemed to have revoked its election.
Ceasing to Report in a Functional Currency
A corporation can revert to reporting in Canadian Dollars either voluntarily or involuntarily. If the corporation does not comply with the requirements of the functional currency election, it will need to report with Canadian dollars. Certain events may also trigger a return to reporting in Canadian Dollars. For example, if a corporation becomes a subsidiary to another corporation which reports in a different currency than the subsidiary's functional currency, the subsidiary is deemed to have revoked its reporting election.
A corporation may voluntarily choose to revoke their functional currency reporting election by filing the prescribed form. The revocation can only be made in years after the corporation's first year reporting with the functional currency. The revocation will be effective for tax years beginning six months after the revocation is filed. As a result, corporations who elect to report in their functional currency must do so for at least two taxation years. Once the corporation ceases to be a functional currency reporter, it cannot begin reporting in a functional currency again.
Tax Tips: Understanding your Corporation's Unique Needs
The benefit in electing to report using a corporation's functional currency is decreasing compliance costs on a year-by-year basis. The corporation does not need to waste the time, effort and accounting expense converting their records to Canadian dollars to comply with their Canadian tax reporting requirements. However, The transition rules to and from functional currency reporting are complicated. For instance, when a corporation with accrued capital gains transitions to functional currency reporting, it is deemed to make a gain according to a specific formula outlined in paragraph 261(10)(a) of the Income Tax Act. Functional currency reporting, because it differs from traditional reporting, requires a specific knowledge of the differing reporting rules. Corporations using functional currency reporting will need to retain qualified experts, like our experienced Canadian tax lawyers, who understand the unique needs of their businesses and reporting requirements.