4 December 2001 External T.I. 2001-0111455 - WITHHOLDING TAX EXEMPTION INTEREST

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

? Clarification of the position stated in Technical Interpretation E9824125 and E9721405 involving conversion rights on securities for the purpose of the exemption from Part XIII withholding tax on interest.

Position:

? Clarify that the above interpretations involved non-prescribed securities and confirm the position set out in paragraph 7 of IT-361R3.

Reasons:

? In the interpretations referred to above, the conditions for the exemption in subparagraph 212(1)(b)(vii) of the Act were not met since it was possible that, under certain circumstances, more than 25% of the principal amount of the obligation could be paid within five years.

TAX EXECUTIVES INSTITUTE CONFERENCE - 2001

Question 7 - Withholding Tax Exemption

Paragraph 7 of IT-361R3 provides that a payment of principal made at the issuer's discretion does not disqualify an obligation from the withholding tax exemption set forth in subparagraph 212(1)(b)(vii) of the Act. There, are however, technical interpretation documents that state that the presence of a conversion option that is exercisable by the issuer at its discretion will disqualify any payment under the obligation from the withholding exemption. Do these technical interpretations accurately state CCRA's position? If so, please explain its position.

CCRA Response

Subparagraph 212(1)(b)(vii) of the Act provides that Part XIII tax is not payable by a non-resident person on interest received from a corporation resident in Canada if, inter alia, under the terms of the obligation or any agreement relating thereto the corporation may not, under any circumstances, be obliged to pay more than 25% of the principal amount thereof within five years of the date of its issue except in the event of, inter alia, the non-resident person exercising a right under the terms of the agreement relating thereto to convert the obligation into, or exchange the obligation for, a security prescribed for this purpose, by subsection 6208(1) of the Income Tax Regulations.

The technical interpretations (#E9721405 dated September 9, 1997, and subsequently #E9824125 dated March 4, 1999) at issue were referring to fact situations involving conversion rights for securities that were not prescribed securities. The right of the holder of the debt obligation to convert that obligation into a non-prescribed security became effective only after the issuer of the debt obligation had given notice to the holder allowing them to make the conversion. Thus it was possible that, under certain circumstances, more than 25% of the principal amount of the obligation could be required to be paid. Those circumstances would be the issuance of the conversion notice by the issuer and the subsequent conversion by the holder. Therefore, we were of the view that the requirements of subparagraph 212(1)(b)(vii) were not met.

The facts as described in the question are not accurate as the conversion option rests with the holder of the debt obligation and not the issuer.

In summary, the position as stated in ¶7 of IT-361R3, Exemptions from Part XIII Tax on Interest Payments to Non-Residents, remains valid. That is, a corporation will not be considered obliged to repay the principal amount of the debt obligation solely because the terms of the debt obligation permit principal repayment at the issuer's discretion of more than 25% of the principal amount within 5 years of the date of its issue.

File # 2001-011145
Prepared by
Bill Kerr
957-3498