Allocation under s. 212(3.2) formula of interest to ultimate funder in excess of actual interest to it (p. 7)
Essentially, the formula allocates to each ultimate funder an amount of deemed interest equal to a proportion of the actual interest paid by the taxpayer. The proportion is determined by reference to the pro-rata share of proportion of the taxpayer's debt that is ultimately funded by the particular ultimate funder (essentially the ratio of the net "funding" provided by the ultimate funder to the amount of the taxpayer's debt) and adjusted for the difference between the withholding tax rate on interest paid to the ultimate funder and the withholding tax rate on the actual interest paid by the taxpayer; it should be noted that the proportion is determined by reference to the average of principal amounts of debt or other obligations outstanding (and the fair market value of property in respect of which specified rights have been granted) under relevant funding arrangements in the period during which the interest accrued on the taxpayer's debt Thus, an ultimate funder could be allocated a pro-rata portion of the deemed interest even though it has provided a non-interest-bearing loan or it has not provided any loan at all but has granted "specified rights".
Likely insufficient information for Canadian taxpayer to evaluate arm’s length test (p.9)
[I]t appears that the "one of the main purposes" test requires the Canadian taxpayer to enquire as to the purpose of a "funding" lease or licence from an arm's length lessee or licensor. In many or most cases, the Canadian lessee or licensor will likely contract with and have contact only with the immediate licensor and therefore likely will not have sufficient information to determine whether or not the test is met.
Potential application to common shares (p. 10)
[T]he Character Substitution Rules…generally apply where a "relevant funder" has an obligation to pay a dividend on its shares (other than "specified shares") or an amount under a rent or royalty arrangement, and either the amount of the payment is determined by reference to an amount of interest paid under a "relevant funding arrangement", or there is a causal connection (similar to that under the BTB Loan Rules) between the shares or rent or royalty arrangement and the "relevant funding arrangement". Where these conditions are satisfied, the rent or royalty arrangement or the holding of the shares, as the case may be, is deemed to be a "relevant funding arrangement" to which the BTB Loan Rules apply.
Since once a dividend on any type of shares is declared, the issuer would generally be considered under most corporate law to have an obligation to pay the dividend, it appears that most types of shares, not just shares with "debt-like" characteristics, may satisfy the first part of the conditions for the application of the Character Substitution Rules. The fact that "specified shares" are specifically carved out of the Character Substitution Rules and treated as debt seems to suggest that the Character Substitution Rules may not be targeting only "debt-like" preferred shares. Thus, the Character Substitution Rules may potentially apply to ordinary common shares on which dividends have been declared during the relevant period and where the requisite tests are met.
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