CRA treats somewhat-discretionary note interest as being interest for Part XIII exemption purposes

CRA ruled that “interest” paid by a resident corporation (Aco) on subordinated notes would not be subject to Part XIII tax based on the exemption from Part XIII tax for non-participating interest paid to arm’s-length recipients, but with the ruling letter stating under “Additional Information” that the interest would not be deductible under s. 20(1)(c) (or s. 9) in computing Aco’s income. Equity-like features of the notes included that:

• they were subject to the right of Aco in its discretion, with prior notice to the holders, to cancel any interest that would otherwise be payable on any due date; however, in such event, Aco would be precluded from declaring dividends or repurchasing shares until interest payments resumed;
• failure to make a payment on the Notes when due (including any interest, whether as a result of cancellation or otherwise) would not trigger an event of default thereunder;
• they had no scheduled maturity or redemption date, so that ACo was not required to make any repayment of the principal except upon an event of default (principally, bankruptcy or insolvency).

Although the CRA summary is cryptic, the analysis might have been that there was no “legal obligation to pay interest” as required under s. 20(1)(c) in light of the first two points above, but that the interest on the Notes was still “interest” for Part XIII purposes. 2016-0649061R3 and 2017-0732001R3 are similar.

Neal Armstrong. Summary of 2020 Ruling 2020-0854741R3 under s. 212(1)(b).