1993 Administrative Letter 9333626 F - Participating Debt

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:

Are Participation Payments Interest

POSITION TAKEN:

No

REASONS FOR POSITION TAKEN:

Contrary to RCT admin position based on facts

LEGAL:

N/A

FINANCE OPINION:

N/A

JURISPRUDENCE:

See file back-up

RCT PUBLICATIONS:

See file back-up

HAA NUMBER:

January 5, 1994

Head Office Head Office

Audit Technical Services Division Rulings DirectorateE. H. Gauthier (613) 957-8953Director

Attn: Larry Jacobson Industry Specialist Services 933362-7

XXXXXXXXXX

Tax Treatment of Participating Loan

We are responding to your memorandum of November 15, 1993, concerning an opinion request from the Montreal District Office in respect of a particular participating loan arrangement (the XXXXXXXXXX) entered into by the above noted taxpayer and XXXXXXXXXX

a tax exempt lender.

We understand that under the terms and conditions of this particular loan, there is no possibility for its early redemption, therefore, the participation payments are expected to continue until the loan matures in 2008. The other pertinent facts of this particular loan arrangement are adequately described in your above noted memorandum and are not repeated herein. Moreover, we understand that these facts are not in dispute with the taxpayer.

Issue

At issue is the whether the participation payments required on the XXXXXXXXXX loan are deductible by XXXXXXXXXX under subsection 9(1) of the Act, as a business or property expense, or under paragraph 20(1)(c) or paragraph 20(1)(e) of the Act, as interest or financing expenses respectively. We understand that you will be using the basis of our analysis to determine the deductibility of participation payments required under the XXXXXXXXXX loan as well.

District Office Opinion

The Montreal District Office is of the view that while the participation payments may be laid out to earn income, they are expenditures on account of capital, therefore, any deduction is limited by paragraph 18(1)(b) of the Act. Moreover, the participation payments are not deductible under paragraph 20(1)(c), as an interest expense, because the payments are not "legally interest", or under paragraph 20(1)(e), as financing expenses, because the payments are not incurred in the course of a borrowing of money. The Montreal District Office relied on the Department's various published comments pertaining to participating loans in support of this position.

Taxpayer's Opinion

The taxpayer's representative, XXXXXXXXXX argues that the participation payments are not on account of capital, and therefore, their deduction is not restricted by paragraph 18(1)(b). Accordingly, it is his view that such expenditures should be deductible as ordinary business expenses based on GAAP or subsection 9(1). In support of this position he refers to an article written by Brian J. Arnold which appeared in the 1992 Canadian Tax Journal (#3), "Is Interest a Capital Expense?".

Alternatively, XXXXXXXXXX argues that even if the participation payments were found to be on account of capital, they should be deductible under either paragraph 20(1)(c), or paragraph 20(1)(e).

Our Opinion

We have carefully reviewed and considered all the facts and information you provided to us with respect to the XXXXXXXXXX loan, including the arguments put forward by the taxpayer's advisor,XXXXXXXXXX in his submission to you dated August 17, 1993, and the copy of the XXXXXXXXXX Participation Agreement.

There is clear authority from the courts that costs in connection with financing are expenditures on capital account unless the taxpayer is engaged in the business of lending money (Montreal Light, Heat & Power Consolidated v. MNR, (1944) 2 DTC 654 (CPC)). Accordingly, it is our opinion that these participation payments are on capital account, and a departure from GAAP is required since paragraph 18(1)(b) specifically precludes their deduction. Therefore, participation payments will only be deductible to the extent, if any, specifically permitted by other provisions of the Act.

Deductibility under paragraph 20(1)(c)

The facts of the XXXXXXXXXX loan indicate that the participation amounts do not represent legal interest because they are not calculated on a daily basis with reference to a principal sum (Miller v. The Queen, 85 DTC 5354 (FCTD)). Nor does the calculation of the participating amounts on this loan conform with the Department's published policy on participating loan arrangements, which were expressed in the 1987 Conference Report (Round Table Q.52), the 1989 Corporate Management Tax Conference ("CMTC") (at pg. 8:10), and the 1992 CMTC (Round Table Q.1). Moreover, there are no "grandfathering rules" to determine the income tax treatment of participating loans which may have been entered into before the Department's views were made public. Therefore, it is our opinion that these payments are not deductible as interest on borrowed money in accordance with paragraph 20(1)(c).

Deductibility under paragraph 20(1)(e)

The Department's position on the applicability of paragraph 20(1)(e) in respect of these types of participation arrangements was also expressed in the 1989 CMTC (at pg. 8:11). Under the terms of the XXXXXXXXXX loan, the participating payments represent additional compensation for the use of borrowed money. Accordingly, it is our view, based on our published position with respect to the Yonge-Eglinton decision, that these particular participation payments are not deductible under paragraph 20(1)(e).

Summary

Based on our understanding of the terms of the XXXXXXXXXX loan, we agree with the Montreal District Office's view that the participation payments are on account of capital, and are not deductible by XXXXXXXXXX under subsection 9(1), paragraph 20(1)(c), or paragraph 20(1)(e) of the Act.for DirectorFinancial Industries DivisionRulings Directorate