CRA ruling contemplates that a perpetual note whose interest payments were optional had non-deductible but withholding-exempt interest

The Rulings Directorate has published a 2017 ruling dealing with the issuance by a public company (ACo) of unsecured subordinated Notes, whose more unusual terms were that:

• ACo may in its discretion elect by notice in writing to cancel the payment of the interest coupons on a going-forward basis, but recognizing that it thereupon loses its right to pay dividends (or the equivalent such as share repurchases) until it recommences interest payments.
• On the occurrence of a specified event (presumably, some sort of financial difficulty), the Notes will be converted into a number of common shares based on a formula-determined conversion ratio (such that the shares' value could be well below that of the converted principal amount).
• “The Notes have no scheduled maturity or redemption date. ACo is not required to make any repayment of the Principal Amount except in the event of an event of default.”

The Ruling “Additional Information” states:

The Interest paid or payable by ACo on the Notes will not be deductible under paragraph 20(1)(c) or any other provision of the Act in computing the income of ACo for any taxation year.

CRA ruled that the interest amounts paid to an arm’s length Noteholder will not be subject to Part XIII tax under s. 212(1)(b). Thus, CRA accepted that the Interest on the Notes was interest, but perhaps did not consider that the Interest was paid “pursuant to a legal obligation to pay interest” as required under s. 20(1)(c). 2017-0732001R3 (which was issued subsequently but published last year) is quite similar (and perhaps even relates to the same ACo).

Neal Armstrong. Summary of 2017 Ruling 2016-0649061R3 under s. 212(1)(b).