4 January 2001 External T.I. 2000-0055475 - REDUCTION OF STATED CAPITAL

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:

Interest deduction on funds borrowed to redeem preferred shares.

Position TAKEN:

Interest may be deductible on amount borrowed up to the stated capital of the shares and or accumulated profits.

Reasons FOR POSITION TAKEN:

See Trans-Prairies decision.

XXXXXXXXXX 							2000-005547
								Yves Leclerc
Attention:  XXXXXXXXXX 

January 4, 2001

Dear Sir:

Re: Interest deduction on funds borrowed to redeem preferred shares

This is in reply to your letter dated November 3, 2000 in which you seek clarification concerning the Canada Customs & Revenue Agency's (the "Agency") policies on deducting interest under paragraph 20(1)(c) when money is borrowed in order to pay dividends or redeem shares.

The facts in your letter appear to relate to a factual situation involving specific taxpayers. As explained in Information Circular 70-6R3, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. Nevertheless, we offer the following general comments in connection with your request.

A corporation may borrow to pay dividends to the extent of its accumulated profits or retained earnings. Accumulated profits or retained earnings, for the purpose of determining eligible borrowing, do not include appraisal surpluses or profits resulting from non arm's length transactions that were carried out on a non-taxable or tax-deferred basis.

A corporation may borrow to return capital on shares provided that the borrowing does not exceed the stated or paid in capital of those shares.

As for a share redemption, a corporation may borrow to the extent of the stated capital of those shares and the accumulated profits or retained earnings that are utilized to effect the redemption. Accumulated profits or retained earnings need not be allocated proportionately among shareholders.

A corporation may borrow to redeem shares issued on a transaction that was subject to an election under section 85 of the Act, to the extent of the stated or paid in capital of those shares as determined under the relevant corporate law plus the accumulated profits or retained earnings that are utilized to effect the redemption. In determining the amount that may be borrowed, neither the paid up capital of the shares nor the details of the section 85 election are relevant. What is relevant is the amount of capital that has been paid in by the shareholder and recognized as such under the applicable corporate law rather than the treatment for tax purposes of the capital contribution.

These comments, of course, are general in nature. These comments may not be applicable in situations in which a series of transactions is undertaken primarily to increase the amount that may be borrowed by a corporate group to effect a return of capital to a shareholder of the group in comparison to the amount that could have been borrowed prior to the series. These situations can only be dealt with on a case by case basis.

We hope that our comments will be of assistance to you.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch