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.
Principal Issues: 1. Is the payment made as consideration for a rate deduction deductible? 2. Is the portion of the payment that relates to reduce interest rate that exceeds the present value of future interest obligations deductible?
Position: 1. Yes 2. No
Reasons: 1. 18(9.1(c) applies 2. No provision
2005-012906
XXXXXXXXXX C. Tremblay, CMA
(613) 957-2139
March 30, 2007
Dear XXXXXXXXXX:
Re: Technical Interpretation - Subsections 18(9.7)
and 18(9.1) of the Income Tax Act ("the Act")
This is in reply to your letter of May 2, 2005, wherein you requested a technical interpretation on the deductibility of a payment made by a borrower to the lender during the term of a loan to reduce the interest rate on the debt obligation.
You have asked us to consider the following situation:
1. Canco and Loanco are both taxable Canadian corporations and wholly-owned subsidiaries of Parentco.
2. Loanco and Canco entered into a loan agreement whereby Loanco made a loan to Canco at a set interest rate.
3. During the term of the loan, interest rates declined.
4. At the middle of the term of the loan, Canco made a payment to Loanco and, in exchange, Loanco reduced the rate at which interest would be payable for the balance of the term of the loan.
It appears that the payment made by Canco exceeded the present value of future interest obligations Canco would have incurred under the debt obligation under the original set interest rate.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only.
We have reviewed your analysis concerning the application of subsection 18(9.7) of the Act to this scenario. In our view, subsection 18(9.7) of the Act does not apply to the above situation. Subsection 18(9.7) of the Act applies where "the amount paid by a borrower at any particular time, in satisfaction of the obligation to pay a particular amount of interest on a debt obligation in respect of a subsequent period or part thereof, exceeds the particular amount of that interest, discounted...". It does not apply where a payment is made for a reduction in the rate of interest payable on a loan.
Although the tax treatment of a payment "..as consideration for a reduction in the rate of interest payable by a taxpayer on the debt obligation" is provided for under paragraph 18(9.1)(c) and subparagraph 18(9.1)(f)(i) of the Act, which applies " in the case of a reduction described in paragraph (c)...", it should be noted that the preamble to subparagraph 18(9.2) of the Act includes, among other requirements, the phrase "...notwithstanding subparagraph (9.1)(f)(i)..." , thus the application of subparagraph 18(9.2) of the Act needs to be considered. When subsection 18(9.2) applies to the exclusion of subsection 18(9.1) of the Act, the payment made as consideration for a reduction in the rate of interest payable on the debt obligation is deemed to be a prepayment of interest payable in a future year, and the result is a lower deduction in earlier years, increasing over time based on what would have been the remaining term of the debt obligation.
Further, a payment is deductible only to the extent that it can reasonably be considered to relate to an amount that, but for the payment, would have been paid as interest by the taxpayer. Whether a payment may reasonably be considered to relate to an amount otherwise payable as interest, is a question of fact. The payment must not exceed the "value" at that time of an amount that, but for the payment, would have been paid or payable as interest on a debt obligation for a taxation year ending after the payment by the taxpayer. In our view, the portion of the payment that exceeds the value at the time of the payment of the interest that would have been paid or payable, that is, the "excess", is not deemed to be interest under subsection 18(9.1) of the Act and is not deductible under any provision of the Act.
We trust the above comments are of assistance.
Yours truly,
R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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