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: See below.
Position: See below.
Reasons: See below.
International Fiscal Association - May 2009
Q.12 Convertible Debt Obligations
At the CRA Round Table at the 2008 Canadian Tax Foundation Annual Conference, the CRA responded to certain questions concerning the tax treatment under Part XIII of the ITA of convertible debt obligations held by non-residents. Following the CRA Round Table, leave to appeal to the Supreme Court of Canada was denied in the case of Provigo Inc., Tembec Inc., and Cascades Inc., 2008 DTC 6601 (FCA).
Now that leave to appeal to the Supreme Court of Canada has been denied in the case of Provigo Inc., Tembec Inc., and Cascades Inc., the CRA appears to be in a position to update its responses given at the CRA Round Table. More specifically, can the CRA provide comments on the following:
1. Can the CRA specify whether the decision of the Federal Court of Appeal in the case of Provigo Inc., Tembec Inc., and Cascades Inc. has influenced its views concerning the application of subsection 214(7) and paragraph 214(8)(c) of the ITA with respect to convertible debentures issued by a Canadian corporation to a non-resident holder?
2. If the CRA considers that a convertible debenture does not qualify as an "excluded obligation" within the meaning of subsection 214(8) of the ITA, what is the CRA's position concerning the application of subsection 214(7) of the ITA to the conversion of a convertible debenture for shares of the issuer when the FMV of the shares issued on the conversion exceeds the principal of the convertible debenture?
More specifically, what is the "price for which the obligation was assigned or otherwise transferred at that time" under paragraph 214(7)(d) of the ITA in that situation? Moreover, does the CRA agree that the "price for which the obligation was issued" under paragraph 214(7)(e) of the ITA in that situation is the issue price of the convertible debenture (i.e. face value less any discount)?
Based on its comments with respect to question 10-3 at the CRA Round Table, the CRA position seems to be that for the purposes of paragraph 214(7)(d), the price of a convertible debenture at the time of its conversion is normally the stated principal amount of the debenture (being the amount added to the stated capital of the shares issued by the debtor corporation on the conversion).
3. Does the "principal amount" of a convertible debenture for the purposes of the application of paragraph 214(8)(c) of the ITA correspond to the stated principal of the convertible debenture or a greater amount equal to the FMV of the shares received on the conversion of the debenture?
4. How should the yield of a convertible debenture be calculated for the purposes of the application of paragraph 214(8)(c) of the ITA?
5. If the CRA takes the position that the "price for which the obligation was assigned or otherwise transferred at that time" under paragraph 214(7)(d) of the ITA is equal to the FMV of the shares received on the conversion by the holder of the convertible debenture, would the CRA consider that the amount deemed to be a payment of interest under subsection 214(7) of the ITA constitutes "participating debt interest" within the meaning of the definition in subsection 212(3)?
6. If subsection 214(7) of the ITA applies to a convertible debenture and the amount deemed to be a payment of interest under subsection 214(7) represents "participating debt interest" within the meaning of the definition in subsection 212(3), would this characterization taint the status of the fixed interest previously paid pursuant to the terms of the convertible debenture (assuming it was not already "participating debt interest"), on the basis that the definition of "participating debt interest" arguably applies to all interest on an obligation when "all or any portion of which interest is...computed by reference to revenue, profit, cash flow,..."?
7. Would the positions of the CRA stated in response to the questions above change if the debt of the issuer is an exchangeable debenture?
Response
There are many varieties of convertible securities in the market. Moreover, the fundamental characteristics of convertible debentures can differ significantly from one situation to another. Accordingly, it is not possible for the CRA to provide general comments or general positions concerning the application of subsection 214(7) and paragraph 214(8)(c) of the ITA with respect to convertible debentures that will apply to all possible situations.
However, we are prepared to provide the following comments concerning traditional convertible debentures. Debentures that we consider to be traditional convertible debentures have in general at least the following terms and conditions:
(a) The debentures are unsecured subordinated debts.
(b) The issuer is a public corporation.
(c) The debentures are issued for a fixed amount of money in Canadian dollars (for instance $1,000) that represents the face value of the debentures. The debentures are issued with no original discount.
(d) The debentures bear interest at a commercial fixed rate per year calculated on their face value. The interest on the debentures is paid by the issuer at least annually.
(e) The debentures are convertible at any time at the holders' option into the common shares of the issuer prior to maturity. Some debentures have an initial non-conversion period.
(f) The terms of the debentures specifically provide either a fixed conversion price (specifying the fixed price paid per common share to acquire the common shares through the conversion of each debenture) or a fixed conversion ratio (specifying the number of common shares that can be obtained for each debenture). The conversion ratio may be determined by dividing the conversion price into the face value of the debenture. In some cases, the security contract may provide for certain changes in the conversion price or conversion ratio over time.
(g) The conversion price exceeds the price at which at which the common shares of the issuer could have been purchased on the market at the time the debentures are issued (for example, with a 25% conversion premium).
(h) The debentures have a specified maturity date.
(i) At maturity, the debentures are redeemable by the issuer at a redemption price of 100% of the face value, plus accrued and unpaid interest.
Subject to certain exceptions, subsection 214(7) of the ITA provides that when a debenture or other debt obligation described in paragraph 214(7)(a) issued by a person resident of Canada is assigned or otherwise transferred by a non-resident person to a person resident in Canada, the amount (the "Excess"), if any, by which the price for which the obligation was assigned or transferred exceeds the price for which the obligation was issued, is deemed (for the purposes of Part XIII of the ITA) to be a payment of interest on that obligation made by the person resident in Canada to the non-resident. Under subsection 214(14) of the ITA, the redemption or cancellation of an obligation held by a non-resident person is deemed to be an assignment of the obligation by the non-resident person for the purposes of section 214 of the ITA. It follows that on the conversion of a convertible debenture into shares of the issuer, there could be a deemed payment of interest.
Where there is a conversion of a traditional convertible debenture by its original holder for common shares of the issuer, it is our view that in general there would be no Excess under subsection 214(7) of the ITA. Accordingly, no amount is deemed to be a payment of interest by the issuer (person resident in Canada) to the non-resident person for the purposes of Part XIII. For the purpose of paragraph 214(7)(d) of the ITA, the price for which the traditional convertible debenture is assigned on the conversion, is the amount determined by multiplying the fixed conversion price by the number of shares received on the conversion, that is, an amount corresponding to the face value of the traditional convertible debenture. This is the price that is determined under the terms and conditions of a traditional convertible debenture. For the purpose of paragraph 214(7)(e) of the ITA, the price for which the traditional convertible debenture is issued is its face value (principal) and issue price.
The comments above are consistent with our general comments in response to question 10-3 at the CRA Round Table at the 2008 CTF Annual Conference, and are not directly influenced by the comments of the Federal Court of Appeal in the case of Provigo Inc., Tembec Inc., and Cascades Inc. The issue in this case involved the application of paragraph 20(1)(f) of the ITA to convertible debts.
Based on our conclusion concerning the non-application of subsection 214(7) of the ITA, it appears that there is no need at this time to comment on your questions concerning subsection 214(8) of the ITA and the definition of "participating debt interest" in subsection 212(3) of the ITA.
We are not prepared at this time to comment on your question with respect to exchangeable debentures without knowing all the relevant facts in relation to a particular situation (including the terms of the exchangeable debentures) and because of time constraints. If you have concerns concerning the application of Part XIII of the ITA with respect to exchangeable debentures in the context of proposed transactions, we encourage you to request an advance income tax ruling.
Prepared by: Robert Gagnon
Date: May 21, 2009
Document no: 2009-032023
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