10 April 1990 Income Tax Severed Letter 7-3812B

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.

We are writing in response to the round trip memoranda of September 6, 1989 and February 22, 1990 from Mr. John Hirsch of your office (section 198-2-1) which included a copy of a written submission from XXX on the issues addressed in our memorandum dated June 28, 1989.

The principal issue which has been raised is the tax treatment under the Income Tax Act (Canada) ("the Act") XXX

Our understanding of the relevant facts concerning the present matter is stated in our memorandum dated June 28, 1989. We do not intend to restate in detail here our position on this matter as set out in the June 28, 1989 memorandum nor the taxpayer's arguments which were addressed therein. The purpose of this memorandum is to provide you with our comment, the additional arguments submitted by the representatives of XXX in their subsequent submission.

Our Position

As stated in our memorandum of June 28, 1989, our position on the appropriate tax treatment of XXX is the following:

XXX

XXX Opinion

XXX opinion, as stated in its written submission, can be summarized as follows:

A) The discounts are in the nature of interest and should be treated for tax purposes as an interest expense pursuant to the provisions of paragraph 20(1)(c) of the Act. XXX is of the view that the discounts have the characteristics of interest firstly in view of XXX. In addition to the cases previously referred to by XXX (Cohen v. M.N.R. [[1957] C.T.C. 251] 57 DTC 1183 and No. 593 v. M.N.R. [21 Tax A.B.C. 240] 59 DTC 104) the XXX of Lomax v. Peter Dixon & Son Ltd. 25 T.C. 353 is referred to in support of its argument.

B) Another argument submitted by XXX in support of the proposition that the discounts are in the nature of interest relates to subsection 12(9) of the Act and section 7000 of the Income Tax Regulations ("the Regulations"). Although the "prescribed debt obligation" rules are primarily directed to the recipient of the interest, it is argued by the taxpayer that a parallel may be drawn to the effect that what constitutes interest income to the lender should, in equity, represent interest expense to the borrower, i.e., XXX. Furthermore, because subsection 7000(3) of the Regulations deems bonuses and premiums to be interest and because discounts are substantially identical to bonuses and premiums from an economic viewpoint, it is argued that discounts should be treated as interest.

C) XXX also refers to subsections 16(2) and 16(3) of the Act to support the argument that discounts are in the nature of interest and argues that although the application of these subsections is limited to very specific circumstances and restricted conditions, these provisions recognize the economic reality that discounts are usually in the nature of interest, in the absence of significant risk factors.

D) Finally, in support of the proposition that the discount is in the nature of interest; XXX refers to the following statement made by Mr. John A. Calderwood, C.A. on behalf of Revenue Canada, Taxation at the 1983 Annual Conference of the Canadian Tax foundation:

• Whether a deep discount is a current or capital item is a question of fact, and thus a factual determination must be made in each case. If factually the discount is an interest expense to the borrower, the effective rate of interest on the issue price can be determined on a compound interest basis. This rate times the issue price will be allowed annually as simple interest under paragraph 20(1)(c). The balance of the deep discount is compound interest and is allowable under paragraph 20(1)(d) only when paid, usually on redemption. We do not contemplate any immediate changes to this policy.

Our Response to XXX Opinions

As stated previously, we will not address here the arguments submitted by XXX which were responded to in our June 28, 1989 memorandum. Our position is quite simple. It is that the discounts are not in the nature of interest as they do not meet the criteria specified in paragraph 3 of Interpretation Bulletin IT-114 dated August 3, 1973. The said discounts fall clearly within the provisions of paragraphs 18(1)(f) and 20(1)(f) of the Act and should be treated accordingly.

We understand that XXX has not submitted any additional evidence which would allow you to conclude that in fact the XXX.

In response to XXX arguments as set out in their submission and summarized above, the following are our comments:

A) The true nature of a "discount" is to be ascertained from all the circumstances of the case and is to be determined in view of the relevant facts. As stated in the decision of Lomax v. Peter Dixon & Son Ltd. there is no presumption in law that a discount at which a loan is made is in the nature of interest. XXX submits that due to the very low risk factor relating to the Debentures the discounts are in the nature of interest. The risk factor is not, in our opinion, to be considered the sole determining factor but must be considered together with the other relevant circumstances.

B) We do not agree that a parallel can be drawn from the prescribed obligation rules in subsection 12(9) of the Act and section 7000 of the Regulations. These rules are applicable to the recipient and not to the payor of interest. Subsection 7000(3) of the Regulations is a deeming provision with restrictive application which cannot be used to interpret or set aside a specific provision of the act such as paragraph 18(1)(f) or 20(1)(f). Furthermore, the discounts may constitute interest income for the recipient without such discounts necessarily being considered a deductible interest expense for the borrower. Reference can be made to the Federal Court of Appeal decision in The Queen v. Timagami Financial Services Ltd. [[1982] C.T.C. 314] 82 DTC 6268 where the Court adopted the following words from the respondent's arguments:

• In Canadian income tax law there are instances... where the act is not symmetrical: that is to say, where deductions and additions to a taxpayer's income are not treated in the same fashion.

C) Subsections 16(2) and 16(3) of the Act are of little assistance in determining the nature of the discounts in the present matter. These provisions require that, in very specific circumstances and under restrictive conditions, discounts are to be included in computing the income of a taxpayer. These very specific provisions cannot be used to interpret or set aside the provisions of paragraphs 18(1)(f) and 20(1)(f) of the Act.

D) XXX last argument to support the position that the discounts are in the nature of interest is a 1983 statement made by a spokesman for the Department. Mr. Calderwood's quoted comments specifically state that they are based on the assumption that if, as a matter of fact, a discount is an interest expense to the borrower, the effective rate of interest on the issue price can be determined on a compound interest basis and the interest would be deductible under paragraph 20(1)(c) of the Act. Thus, Mr. Calderwood's remarks contain a specific acknowledgement that the true nature of a discount is a question of fact. His comments do not state and can not be construed as stating that discounts are always in the nature of interest. As stated in paragraph 3 of Interpretation Bulletin IT-114, this question must be determined based on the facts and ascertained from all the circumstances of each particular case.