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:
Whether a premium received by the issuer of a debt obligation where the issuer is not in the business of lending money would be characterized as a payment on account of the capital of the issuer and as such would be considered a non-taxable receipt.
Position TAKEN:
None. General comments.
Reasons FOR POSITION TAKEN:
Special Release dated June 10, 1994 cancelled IT-114 which set out CCRA's previous position in regards to this issue. Thus, CCRA does not presently have a published position on the principal issue in this file.
Following the decisions of the Supreme Court in Singleton and Ludco, the CCRA announced that it was examining all of its interpretative and administrative positions regarding interest deductibility and that prior to completing its review, the CCRA does not intend to modify any of its existing practices with regard to interest deductibility. Thus, we must await the outcome of the review before adopting a position on this issue.
XXXXXXXXXX 2001-011232
P. Diguer
July 3, 2002
Dear XXXXXXXXXX:
Re: Premium received by the issuer on the issuance of a debt obligation
This is in reply to your letter dated November 23, 2001, in which you request our views on the characterization of a premium received by the issuer of a debt obligation.
In particular you describe a situation where a taxable Canadian corporation (the "Issuer") carrying on an active business in Canada borrowed money and as evidence of the borrowing issued debentures (the "Original Debenture Issue"). The Original Debentures were issued at par with a stipulated interest rate equal to the market interest rate prevailing at that time and with a term of 25 years. There was no discount or premium on the original issuance of the debentures. The Issuer is not in the business of lending money. All proceeds from the Original Debenture Issue were used by the Issuer for business purposes.
Several months after the date of the Original Debenture Issue, the Issuer requires additional funds also to be used for business purposes. In this regard the Issuer will make a second offering of debentures (the "Second Debenture Issue") by way of a reopening of the Original Debenture Issue. Reopening the Original Debenture Issue will allow the Issuer to benefit from administrative efficiencies and will also likely increase liquidity to holders of the Original Debentures and Second Debentures.
The Second Debenture Issue will be issued at a premium of two percent (2%) (the "Premium"). The Premium reflects the current economic environment of rapidly decreasing interest rates. The effect of the Premium and the interest rate is to bring the future yield on those debentures to prevailing market levels at the time of the Second Debenture Issue.
In particular you ask:
? Is the Premium received by the Issuer a non-taxable capital receipt?
? If the Premium received by the Issuer is a taxable capital receipt, is the Premium required to be included in income in the year of receipt, at maturity or amortized over the remaining term of the Second Debenture?
? Is the full amount or a lesser amount of interest paid or payable by the Issuer deductible under paragraph 20(1)(c) of the Act at the time such interest is paid or payable?
? Will the general anti-avoidance rule ("GAAR") be applied to either treat the Premium as income to the Issuer or to reduce the interest deduction?
The situation that is described in your letter appears to involve a series of actual completed transactions involving specific taxpayers. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular IC-70-6R5 dated May 17, 2002. Where the particular transaction is completed, the inquiry should be addressed to the relevant Tax Services Office. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which we hope are of assistance to you.
Issue premiums normally arise as a result of the establishment of the rate of interest on a debt obligation prior to its issue such that the rate so determined, exceeds the market interest rate for similar instruments at the time of its issue. Accordingly, the issuer is able to require the payment of a premium over and above the repayment obligation or face amount of the debt obligation. In economic terms, such an issue premium serves to adjust the interest yield to reflect the market yield currently being offered on similar instruments.
The courts have enunciated the general principle that money received for capital purposes constitutes a capital receipt. In this regard see Lomax (H. M. Inspector of Taxes) v. Peter Dixon and Sons Ltd, [1943] TR 221. As stated in your letter, CCRA's view, as set out in paragraph 29 of Interpretation Bulletin IT-114 which was cancelled by Special Release issued on June 10, 1994, was that provided the issuer is not in the business of lending money the amount of a premium on the issue of an obligation is not regarded as income. In effect, CCRA generally considered a premium on the issue of an obligation in situations where the issuer is not in the business of lending money to be a payment on account of the capital of the issuer and as such was treated as a non-taxable receipt.
However, in response to question # 20 at the 1994 Association de Planification fiscale et financière (APFF) Conference Round Table, CCRA explained that:
Interpretation Bulletin IT-114, issued in 1973, was cancelled in full because it did not reflect significant changes to the Income Tax Act and was no longer a useful guide to the taxation of discounts, premiums and bonuses relating to a multiplicity of financial products that have changed considerably.
For example, the bulletin was issued before the introduction of the rules concerning prescribed debts. The comments in the bulletin in respect of debts issued at a discount (treasury bonds) or with a bonus on maturity were no longer relevant taking these rules into account. The bulletin also contemplated obligations with a premium on issue by reason of a small variation between the interest rates on the obligations and prevailing market rates at the time of their issue. The comments relating to this type of premium were not appropriate to new types of financial transactions (e.g. weak currency borrowings).
It is unlikely that another bulletin on the topic will be published. However the Department may issue a series of bulletins on individual topics in the future.
(Our emphasis added)
Since the cancellation of IT-114, the CCRA has not issued any bulletins on the taxation of discounts, premiums and bonuses in connection with obligations.
The Supreme Court of Canada recently rendered its decisions on the H.M. The Queen v. Singleton, 2001 SCC 61 and Enterprises Ludco Ltée et al v. H.M. The Queen, 2001 SCC 62 (SCC); cases in favour of the taxpayers. The issue in these cases was the deductibility of interest under the Income Tax Act (Canada) (the "Act"). Following the release of the Singleton and Ludco decisions, we announced that the CCRA was reviewing the decisions and that this would encompass an examination of all of the CCRA's interpretative and administrative positions regarding interest deductibility. We further stated that the nature and scope of the review does not allow us to anticipate when we will be in a position to announce the results of our analysis. However, in the interim period, we stated that the CCRA does not intend to modify any of its existing practices with regard to interest deductibility.
With regard to the general anti-avoidance rule (GAAR), the CCRA's general practice is to comment on the application of subsection 245(2) of the Act only after reviewing all the facts and circumstances of a transaction and after receiving a request for an advance ruling, made according to the terms and conditions in Information Circular 70-6R5, by a taxpayer or his or her duly authorized representative.
Thus, the issue of the characterization of a premium received by the issuer of a debt obligation in the situation described in your letter can only be considered by the CCRA once we have completed of our review.
Yours truly,
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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