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. Whether regular periodic interest payments on standard convertible debentures constitute "participating debt interest"? 1. Whether the deemed payment of interest under subsection 214(7) for standard convertible debentures constitutes "participating debt interest"?
Position: 1. & 2. Generally no.
Reasons: 1. & 2. See below.
NOVEMBER 26, 2013 ROUND TABLE DISCUSSION
2013 CTF 65th ANNUAL CONFERENCE
Part XIII Tax in Respect of Convertible Debentures
The Income Tax Rulings Directorate ("ITRD") recently issued a favourable ruling (document 2011-0418721R3, "Letter") to the effect that paragraph 212(1)(b) of the ITA did not apply to regular periodic interest payments on certain convertible notes issued to non-residents, provided that the public corporation deals at arm's length with the non-resident at the time of the payments.
In response to question 9 at the CRA Round Table at the May 2013 IFA International Tax Seminar, CRA noted that the ITRD was examining certain questions of interpretation and submissions made by the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada ("Joint Committee") concerning the possible application of Part XIII tax with respect to "standard convertible debentures" (as described by the Joint Committee in its letter dated May 10, 2010) issued by issuers in Canada. The CRA noted at that time that its analysis of the relevant issues was substantially advanced, but that the ITRD needed to obtain the views of the Department of Finance concerning the tax policy in relation to these issues before it provides any guidelines to the Joint Committee concerning convertible debentures.
Is there anything new to report?
The ITRD's analysis of the relevant issues concerning the possible application of Part XIII tax with respect to standard convertible debentures issued by issuers in Canada has so far been restricted to convertible debentures issued by public corporations.
In June 2012, ITRD issued the Letter with respect to regular periodic interest payments made on certain convertible notes issued by a Canadian public corporation to a non-resident corporation. The rulings given provided that:
- For the purposes of paragraph 212(1)(b) of the ITA, the regular periodic interest payments made by the public corporation on the convertible notes are not "participating debt interest" within the meaning of the definition in subsection 212(3) of the ITA.
- The regular periodic interest payments made by the public corporation to the non-resident corporation are not subject to Part XIII withholding tax under paragraph 212(1)(b) of the ITA, provided that the issuer deals at arm's length with the non-resident corporation at the time of the payments.
Regular Periodic Interest Payments on Standard Convertible Debentures
The CRA's view is that regular periodic interest payments made by public corporations pursuant to the terms and conditions of standard convertible debentures do not generally constitute "participating debt interest" as defined under subsection 212(3) of the ITA.
Subsection 214(7) and its Interaction with the Definition of "Participating Debt Interest"
The more difficult issue is whether the deemed payment of interest under subsection 214(7) of the ITA would constitute participating debt interest because of the application of the deeming rule in subsection 214(7) in the context of a particular transaction involving standard convertible debentures, and taking into consideration the terms and conditions of a particular standard convertible debenture (including anti-dilution provisions). The scope of the deeming rule in this context is unclear.
Accordingly, the CRA will interpret subsection 214(7) of the ITA and its interaction with the definition of "participating debt interest" in subsection 212(3) of the ITA, in light of the purpose underlying these provisions, their context and the scheme of the ITA.
It is the CRA's view that the deemed payment of interest on standard convertible debentures under subsection 214(7) of the ITA that arises because of a transfer or assignment of standard convertible debentures by a non-resident person to a person resident in Canada (including the issuer of the debenture), does not generally constitute "participating debt interest".
We find no indication in section 212 and the scheme and legislative history of the ITA, that it was the intention of the legislator that any conversion premium (the amount by which the price for which a convertible debenture was assigned or transferred exceeds the price for which the convertible debenture was issued) realized on a conversion or disposition of standard convertible debentures should be treated as "participating debt interest" (as defined in subsection 212(3) of the ITA) and subject to the Part XIII tax.
Subsection 214(7) of the ITA does not apply to an "excluded obligation" as described in subsection 214(8) of the ITA. Subsection 214(8) of the ITA provides that a debenture that satisfies the two tests in paragraph 214(8)(c) constitutes an excluded obligation.
The CRA is not inclined at this time to take the position that standard convertible debentures would in general constitute "excluded debt obligations" pursuant to paragraph 214(8)(c) of the ITA.
We doubt that it was the intention of the legislator that paragraph 214(8)(c) of the ITA should apply with respect to convertible debts.
Moreover, the application of paragraph 214(8)(c) of the ITA in the context of standard convertible debentures raises difficult interpretation issues, including how to determine their yield.
In any event, the application of paragraph 214(8)(c) of the ITA in the context of standard convertible debentures becomes academic when the excess determined under subsection 214(7) of the ITA does not constitute "participating debt interest" and the issuer and holders of the convertible debentures deal at arm's length.
The CRA cannot provide certainty concerning the application of Part XIII tax to the very broad range of situations in which convertible debentures can be issued. They can be issued by corporations (public and private), trusts and partnerships. Their terms and conditions can be complex due to the wide variety of products available in the marketplace, and the particular circumstances and the terms and conditions of the debentures may differ from one situation to another.
As a result, it is not possible for the CRA to anticipate the result of the application of subsection 214(7) and the definition of "participating debt interest" in subsection 212(3) of the ITA with respect to all possible situations involving convertible debts.
The ITRD continues to encourage issuers and/or holders of convertible debts to request advance income tax rulings if they have concerns about the application of Part XIII of the ITA to convertible debts in the context of proposed transactions. Provided that a ruling request is received prior to the issuance of the convertible debts, the ITRD will examine the request and the rulings would generally apply prospectively to future regular periodic interest payments, conversions or sales of convertible debts.
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2013
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2013