Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Where a corporation issued bonds at a deep discount and carries those bonds on its balance sheet at the original issue price plus an amount "accreted" in respect of the discount each year to maturity, may the accreted amount be deducted from the amount reflected on the balance sheet in calculating the amount of indebtedness reflected by bonds for the purposes of subparagraph 181.2(3)(d)? Does the accreted amount have the nature of interest and thereby constitute "other indebtedness" within the meaning of subparagraph 181.2(3)(f)?
Position: The full amount reflected on the balance sheet is indebtedness reflected by bonds. No amount may be deducted in assessing the amount to be included under 181.2(3)(d).
Reasons: Subparagraph 181.2(3)(f) has no application to amounts that are otherwise described in subsection 181.2(3). The entire amount that is reflected on the balance sheet is described in paragraph 181.2(3)(d).
November 6, 2000
TORONTO NORTH TSO HEADQUARTERS
Attention: Charles Berdugo (613-957-9226)
Deep Discount Debt and Part I.3 Tax
This is in reply to your note dated October 11, 2000 requesting our comments on the appropriate application of Part I.3 of the Act to debt issued at a deep discount.
As we understand it, the taxpayer issued debt in XXXXXXXXXX at a discount of XXXXXXXXXX% from its face value and having a XXXXXXXXXX% yield to maturity. No cash interest was payable until XXXXXXXXXX. The debt is carried on the taxpayer's balance sheet at an amount equal to the original issue price and amounts "accreted" to date. The accreted amounts are based on a specified rate per annum, computed on a daily basis and compounded semi-annually from the date of issuance, such that the total amount of the discount will be accreted as of the date of maturity of the notes.
The taxpayer has, for accounting purposes, expensed the accreted amounts as interest and, with some adjustments, deducted that interest as a current expense for tax purposes.
It is also our understanding that the taxpayer's view is that the accreted amounts have the character of interest and as such, are not included in capital in the year of accretion. In this respect, they rely on paragraph 181.2(3)(f) which includes in a corporation's capital "other indebtedness...at the end of the year that has been outstanding for more than 365 days before the end of the year". The taxpayer's argument is that the accreted amount has been outstanding less than 365 days as at the end of the year.
Our views are as follows. A corporation's capital for the year includes, pursuant to paragraph 181.2(3)(d):
(d) the amount of all indebtedness of the corporation at the end of the year represented by bonds, debentures, notes, mortgages, bankers' acceptances or similar obligations,
It is our view that the debt at issue is clearly debt represented by bonds, and hence included in the corporation's capital pursuant to that paragraph. It is also our view that paragraph 181.2(3)(f) thereby does not apply in respect the debt. The reference to "other indebtedness" in that paragraph makes clear that paragraph 181.2(3)(f) applies only in respect of indebtedness that is not otherwise described in subsection 181.2(3).
Subsection 181(3) of the Act provides that, for the purposes of determining any amount under Part I.3 in respect of a corporation's capital, the amounts reflected in the corporation's balance sheet prepared in accordance with GAAP and presented to the shareholders shall be used. In the present case, the amount reflected on the balance sheet includes the accreted amounts.
Paragraph 10 of IT-532 provides that, where the amount reflected on a corporation's balance sheet represents aggregated or pooled balances of amounts of a different nature, the underlying balances will be examined to ascertain the relevant amount of a particular amount for Part I.3 purposes. It is our view that this position would only be relevant to the debt at hand if it is established that the accreted amounts do not represent indebtedness of the corporation represented by bonds. Our view is that the accreted amounts do represent indebtedness of the corporation represented by bonds and that paragraph 10 of IT-532 is therefore not relevant.
In fact, it is our view that an argument exists that the full face value of the bond, without any reference to the bond discount, is the appropriate amount to be included in capital. As noted above, in assessing amounts for Part I.3 purposes, the amounts reflected in a corporation's balance sheet prepared in accordance with GAAP shall be used. This includes amounts reflected in the notes to the financial statements. Where an amount described in subsection 181.2(3) is reflected in the notes to the financial statements, it may be considered in assessing the amount subject to tax under Part I.3. See paragraph 6 of IT-532 in this respect.
Where a bond is issued at a discount, our understanding is that the full legal liability in respect of the bond would generally be reflected in the notes to the balance sheet. Your referral does not indicate whether or not this is true of the financial statements at issue. However, it the CCRA's practice to not include amounts reflected in the notes where a bond is issued at a discount, unless the full face amount of the bond is reflected on the face of the balance sheet. See, in this respect, paragraph 37 of IT-532. In general, amounts reflected only in the notes to the financial statements are added to a corporation's capital only where it can be established that the additional amount actually reflects capital available to a corporation.
In this case, our view is that the amount of capital available to the taxpayer in respect of the bonds is the amount reflected on the face of the balance sheet. In this respect, it should also be kept in mind that the corporation is charging the accreted amount to its retained earnings each year. A failure to include the accreted amount in capital as indebtedness in respect of the bond would actually result in the corporation realizing a reduction in its capital each year in respect of the bond. Put another way, the inclusion of the accreted amount in the corporation's capital each year does not result in an increase in the corporation's overall capital; rather, it prevents the corporation from realizing an inappropriate decrease in its capital.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.
F. Lee Workman
Financial Industries Division
Income Tax Rulings Directorate
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