CRA rules that a variable return at note maturity linked to a non-resident company’s stock was not participating debt interest

A Canadian public corporation (ACO) will issue unsecured and unsubordinated notes to non-residents with whom it deals at arm’s length. The issue price for each Note will equal its principal and correspond to the value of a ‘Reference Stock” on the date issued. The Reference Stock will be proposed by the noteholder but must be a listed stock of a non-resident issuer dealing at arm’s length with ACO and must have a correlation to ACO’s common shares that is lower than that of the S&P 500 index to ACO’s common shares. The Notes will bear interest at a stipulated rate expressed as a percentage of the Principal Amount.

At maturity, ACO will pay an amount equal to the closing price of the Reference Stock if it does not exceed the “Cap Price,” and otherwise will pay the Cap Price. ACO may elect to repay the Note at maturity with Reference Stock.

CRA ruled that the exclusion for participating debt interest did not apply. Its summary indicated:

[C]onsistent with the policy of the provision, the payments are not tied to the profitability of the issuer. In other words, the payments do not represent a disguised payment of profits out of Canada.

Neal Armstrong. Summary of 2021 Ruling 2020-0865991R3 under s. 212(3) – participating debt interest.