18 November 2014 Roundtable, 2014-0550401C6 - 2014 TEI Liaison Meeting, Q. E3

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: Whether subsection 39(3) of the Income Tax Act applies in certain scenarios where bonds are repurchased and whether each constitutes an open market purchase: 1) A debt tender offer where a company makes a public offer to its bondholders to repurchase a predetermined number of bonds at a specified price. 2) In some cases, certain investors will own a significant amount of a particular issuer's bonds. Consider the case where a bond issuer enters into a transaction directly with one or more selected bondholders and agrees to repurchase all or a portion of the issuer's bonds held by the selected investor-holder. 3) Some bonds are callable, with the issuer having a right under certain conditions to redeem the bond prior to its maturity date. Consider an example where an issuer has issued callable bonds and subsequently exercises the call to force the redemption of the bonds.

Position: 1) Generally a tender offer (i.e. an offer which requires an acceptance by the holder in the form of a tender of the relevant obligation by the holder directly to the issuer) is not considered to be an open market repurchase for purposes of subsection 39(3). 2) Generally, a bond repurchase that is negotiated and concluded directly between an issuer and a holder is not considered to be an open market repurchase for purposes of subsection 39(3). 3) Generally, the exercise by the issuer of an early repayment right pursuant to the terms of a bond is not considered to be an open market repurchase for purposes of subsection 39(3).

Reasons: See complete response.

2014 TEI-CRA Liaison Meeting
November 18, 2014

Question E3 - Bond Repayments – Non-Financial Institutions

Many Canadian taxpayers have issued bonds, debentures and similar obligations. Many of the instruments bear interest at rates higher than currently prevailing market rates. Hence, these companies are evaluating alternatives to refinance or repay their higher interest rate debts to lock in the advantage of the current low interest rate environment and reduce the overall costs of debt.

In many cases, the repayment of a higher rate obligation prior to maturity entails the payment of a penalty, bonus, or premium over the face amount that represents compensation for the interest-rate spread between the rate on the obligation and the current market interest rates. In this context, when bonds are purchased in the open market by the issuing company the price will exceed the greater of the principal amount of the obligation and the amount for which it was issued by the taxpayer. By virtue of paragraph 39(3)(b) of the Act, the excess amount (assuming the transaction is not an income transaction under the general rules for distinguishing income from a capital gain) would generally be deemed to be a capital loss of the taxpayer for the taxation year from the disposition of a capital property. See, e.g., Technical Interpretation 2000-0036825 (September 13, 2000).

If the manner of repayment is not considered a purchase in the open market by the issuing company in the manner in which open market purchases are normally made by the general public, subsection 39(3) should not apply. Rather, subsection 18(9.1) of the Act may apply in respect of a penalty or bonus amount as described in paragraph 18(9.1)(d). Where all the conditions in subsection 18(9.1) are satisfied, the penalty or bonus amount may be deducted as interest in accordance with that subsection.

There are a number of alternative methods companies can use to facilitate the repayment of debt obligations. Many bonds do not trade publicly on a stock exchange and instead trade off-market or "over-the-counter." In evaluating the potential application of subsection 39(3) to bond repurchase transactions it is not always clear what constitutes a "purchase in the open market in a normal manner by any member of the public." Accordingly, we request that the Agency provide its views on whether the bond buyback or repurchase transactions noted below are within (or outside) the purview of subsection 39(3) and indicate whether each constitutes an open market re-purchase:

1. A debt tender offer where a company makes a public offer to its bondholders to repurchase a predetermined number of bonds at a specified price.
2. In some cases, certain investors will own a significant amount of a particular issuer's bonds. Consider the case where a bond issuer enters into a transaction directly with one or more selected bondholders and agrees to repurchase all or a portion of the issuer's bonds held by the selected investor-holder(s).
3. Some bonds are callable, with the issuer having a right under certain conditions to redeem the bond prior to its maturity date. Consider an example where an issuer has issued callable bonds and subsequently exercises the call to force the redemption of the bonds.

CRA Response:

It is the CRA's position that the phrase "purchased the obligation in the open market, in the manner in which any such obligation would normally be purchased in the open market by any member of the public" for the purpose of subsection 39(3) of the Income Tax Act means that the obligation must be purchased on an exchange or over the counter through an independent party in accordance with the procedures and requirements of the relevant securities legislation and the by-laws or regulations of the relevant exchange or trading platform. If the vendor and the purchaser have made an arrangement with respect to the purchase and sale of the obligation in question, the purchase would not be considered to be carried out in the manner in which any member of the public would normally purchase obligations in the open market. Indeed, if the identities of both the purchaser and the vendor are known to each other with certainty, generally the bonds would not be considered to be purchased by the issuer in the open market in the manner in which bonds would normally be purchased by any member of the public. In our view, the provisions of subsection 39(3) of the Act may not apply if the issuer of a debt obligation is not bidding in competition with the general public or if the issuer exercises advantages or special rights not available to the general public.

In respect of the particular questions posed by TEI:

Generally a tender offer (i.e., an offer which requires an acceptance by the holder in the form of a tender of the relevant obligation by the holder directly to the issuer) is not considered to be an open market repurchase for purposes of subsection 39(3).

Generally a bond repurchase that is negotiated and concluded directly between an issuer and a holder is not considered to be an open market repurchase for purposes of subsection 39(3).

Generally the exercise by the issuer of an early repayment right pursuant to the terms of a bond is not considered to be an open market repurchase for purposes of subsection 39(3).

Lara Friedlander
2014-055040