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: Status of CRA's position on monetization arrangements.
Position: See below.
Reasons: See below.
2010 Canadian Tax Foundation Conference
CRA Round Table
October 8, 2010
Question 36 - Monetization of Securities
The Income Tax Rulings Directorate has issued advance rulings letters concerning monetization arrangements of shares of public corporations. The proposed transactions in certain advance rulings letters (documents 9719413, 9809643 and 1999-0008753) involved the issuance of exchangeable debentures. The proposed transactions in an advance rulings letter (document 2007-0246461R3, modified by document 2008-0276821R3) included a combination of a forward contract and a loan.
At the Canadian Tax Foundation's 2009 annual conference, the CRA mentioned that it had changed its position on the application of paragraph 20(1)(f) to exchangeable debentures. The new position is that the appreciation of the principal amount of the debenture over its face value is not deductible under paragraph 20(1)(f). The change to the CRA's position will be administered on a prospective basis to debentures issued on or after January 1, 2010. In this respect, a debenture issued prior to January 1, 2010, but modified on or after that date will be considered issued on or after January 1, 2010. On the basis of this change of position, it appears to us that it is not possible in practice to implement monetization arrangements with exchangeable debentures.
Question to the CRA
Is the CRA's position still the same with respect to monetization arrangements of shares of public corporations as described in document 2007-0246461R3 and including a combination of a forward contract and a loan?
CRA's Response
The Income Tax Rulings Directorate recently refused to issue an advance rulings letter with respect to a monetization arrangement including a proposed series of transactions similar to the proposed series of transactions described in document 2007-0246461R3.
Ruling F in document 2007-0246461R3 provides that the amounts that will be received or paid by the corporations in settlement of the rights or obligations flowing from the forward contract will be on account of capital.
We are now of the opinion that the return that was included in the forward contract (through an increase of the forward price) would constitute income rather than capital. It should be noted that the agreement that was designated as a forward contract in document 2007-0246461R3, now appears to us to be more in the nature of an equity swap.
It appears to us that when a monetization arrangement includes a return that is calculated like interest and is integrated in the forward contract, the purposes of this return are in general to artificially increase the interest expense that would otherwise be charged by the financial institution on the loan, and to characterize the return as a capital gain or a reduction of a capital loss. Depending on the circumstances, the CRA could take the position that part of the interest expense is not deductible under paragraph 20(1)(c) on the basis that the interest expense is not reasonable.
It is important to note that in ruling F of document 2007-0246461R3, the CRA did not state that the loss that would result from the settlement of the obligations of a corporation under the forward contract, in the event of an increase in the value of the monetized shares, would constitute in and by itself a capital loss. In such a situation, it appears to us that this loss would not technically constitute a capital loss under the provisions of the ITA solely by reason of the settlement of the forward contract.
Tax specialists should not assume that GAAR is never applicable to monetization arrangements involving shares of public corporations on the basis of the advance ruling letters mentioned above. The advance rulings given on subsection 245(2) have been issued on the basis of the particular facts and the representations provided to the effect that the transactions were undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit.
The CRA has not yet determined all the tax consequences that could be applicable with respect to all conventional methods of monetization of shares of public corporations.
Robert Gagnon
2013-050719
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