Understanding Functional Currency and Its Impact on SR&ED Claims

Effective December 13, 2007, certain Canadian corporations have the option to file their T2 corporate tax returns in a currency other than the Canadian Dollar (CAD). This provision, outlined in Section 261 of the Income Tax Act, offers flexibility for businesses operating in multiple currencies. However, it’s crucial for corporations to understand how choosing a functional currency affects their Scientific Research and Experimental Development (SR&ED) claims.

What is Functional Currency?

Functional Currency is “the primary currency in which the corporation keeps its records and books of account for financial reporting purposes for the tax year.”¹ Selecting the correct functional currency is essential for accurate financial reporting and compliance with tax regulations. The CRA specifies that:

[…] in order for a currency to be a taxpayer’s functional currency for a tax year, the foreign currency must be the primary currency in which the taxpayer maintains its books and records of account for financial reporting purposes throughout the particular tax year. Whether a currency is a taxpayer’s primary currency for financial reporting purposes is a question of fact. In general, the primary currency condition will be met where that currency is its functional currency for financial accounting purposes. In contrast, where a taxpayer’s functional currency for financial accounting purposes is Canadian dollars, the taxpayer will not have a functional currency for income tax purposes simply by maintaining records and books of account in a qualifying foreign currency.²

Filing the T2 in a Non-Canadian Currency

Corporations eligible to file their T2 returns in a currency other than CAD must adhere to specific conditions outlined in subsection 261(3) of the Income Tax Act. For SR&ED claims, it’s imperative to file in the same currency as the T2 to ensure consistency and compliance.

Eligibility Criteria

To file in a currency other than the Canadian Dollar, corporations must satisfy the following five conditions:

1. Corporate Residency and Type
   • The taxpayer must be a corporation resident in Canada.
   • Exclusions: Investment corporations, mortgage investment corporations, and mutual fund corporations are not eligible.
2. Election with the Minister
   • The corporation must file an election with the Minister using the prescribed form (T1296: Election, or Revocation of an Election, to Report in a Functional Currency).
   • Timing: The election must be made no less than six months before the end of the tax year.
   • Permanence: The election applies to all future years unless it is explicitly revoked.
3. Primary Accounting Currency
   • The primary currency used for maintaining books and records must be one of the four qualifying currencies as defined by the Act.
4. No Prior Election
   • The corporation must not have previously filed an election to use a functional currency.
   • Restrictions: Once an election is revoked, the corporation cannot change its elected functional currency or re-elect to report in a functional currency.
5. Non-Revocation for the Year
   • The corporation must not have revoked the election for the particular tax year in question.³

Qualifying Currencies

The four qualifying currencies typically include major international currencies such as the US Dollar (USD), Euro (EUR), British Pound (GBP), the Australian dollar (AUD), and Japanese Yen (JPY).⁴ It’s essential to verify the list of qualifying currencies based on the latest guidelines from the Canada Revenue Agency (CRA).

Converting to Functional Currency

Once a corporation meets all eligibility criteria, it can proceed to file its T2 and SR&ED claims in its elected functional currency. The conversion from Canadian Dollars to the functional currency should use the relevant spot rate, defined as:

The noon rate quoted by the Bank of Canada on a particular day or the closest preceding day if no such rate is quoted on a particular day.⁵

Relevant spot rates can be retrieved from the Bank of Canada’s website.

Functional Currency Considerations for SR&ED Claims

The CRA states that SR&ED claims must be converted to the same functional currency as  as the company’s T2.⁶ When submitting an SR&ED claim using a functional currency, corporations should ensure the following:

1. Consistent Conversion:
   • All Expenditures: Salaries and wages, contractor costs, materials costs, and Property, Plant, and Equipment (PP&E) expenditures must be converted using the relevant spot rate.
   • Taxable Capital and Income: These figures, used to calculate expenditure limits, should also be converted into the functional currency.
2. Expenditure Limits:
   • It’s advisable to convert expenditure limit values into the functional currency. This practice helps ensure that the corporation does not exceed its refundable tax return limits.
3. Documentation:
   • Maintain thorough records of all conversions and the rates used. Proper documentation is crucial for audit purposes and to substantiate the figures presented in the SR&ED claim.

Recommendations for Functional currency in SR&ED

Early Election: Corporations considering filing in a functional currency should make the election early to align with the election deadline and the SR&ED claim deadlines:

The election to report in a functional currency must be filed within the first 61 days of the tax year to which the election applies.⁷

Our articles “Filing Late – Will it Impact SR&ED?” and “Can you apply for the SR&ED credit past the filing deadline?” have more information regarding the SR&ED due dates and deadlines.

Consult Professionals: Navigating currency conversions and understanding tax implications can be complex. It’s advisable to consult with tax professionals or accountants experienced in SR&ED claims and corporate tax filings.

Stay Updated: Tax laws and regulations can change. Regularly review updates from the CRA to ensure ongoing compliance.

Conclusion

Choosing to file the T2 and SR&ED claims in a functional currency other than the Canadian Dollar offers flexibility for eligible corporations. However, it requires careful adherence to the conditions set forth in the Income Tax Act and meticulous record-keeping. By understanding the requirements and implications, businesses can effectively manage their tax filings and maximize their SR&ED benefits.