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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Income tax treatment of various compensating payments and interest where a debt is assumed with an interest rate in excess of current market rates.
Position TAKEN:
Compensating payments not deductible but income to recipient - interest on assumed debt not deductible.
Reasons FOR POSITION TAKEN:
Compensating payments are not legally interest - 20(1)(c)(ii) does not seem to apply.
Revenue Canada Round Table
TEI Conference
May 16, 1994
Question XIV
PAYMENTS IN EXCESS OF FACE BY DEBTORS
FOR ASSUMPTION OF THEIR LIABILITIES
A liability of a debtor ("Co. A") carries a stated interest rate which is higher than current market interest rates and is owed to an arm's length creditor ("Co. B"). Another arm's length taxpayer ("Co. C") irrevocably assumes, Co. A's liability in exchange for Co. A's payment of an amount representing the fair market value of the liability. The payment received by Co. C may include an amount representing the accrued interest on the liability to the date of the assumption, as well as an amount representing the discounted value of the excess interest rate differential (the "reverse premium").
1.Assuming that interest payable on the liability qualified for deduction by Co. A pursuant to paragraph 20(1)(c) of the Act, would the reverse premium paid by Co. A also be deductible? If so, would it have to be amortized?
2.Provided and to the extent that the cash or any substituted property were used by Co. C for the purpose of gaining or producing income, would the interest accruing following the assumption of the liability be deductible by Co. C pursuant to subparagraph 20(1)(c)(ii)?
3.Assuming the answer to question 2 is affirmative, would the interest accrued to the date of the assumption be deductible by Co. C when it is paid to Co. B?
4.Would the amount received by Co. C on account of the accrued interest to the date of assumption and the reverse premium be included in computing its income, and if so, on what basis? Additionally, if, consistent with GAAP, the reverse premium received by Co. C is amortized against the interest payable on the liability assumed by Co. C, would this treatment be acceptable for income tax purposes in accordance with section 9 of the Act?
Department's Position
The determination of the proper income tax consequences of these types of transactions will depend on a complete examination of all the relevant facts, circumstances and underlying documentation relating to the particular transaction. Our response that follows has been formulated without the benefit of this information, or our having dealt previously with this type of transaction in the context of an advance income tax ruling.
1.It appears that the reverse premium Co. A pays to Co. C is not deductible by Co. A as interest under paragraph 20(1)(c) because it is not interest. Moreover, for Co. A to be able to deduct this amount under section 9, it would have to demonstrate that the payment was made for the purpose of gaining or producing income from its business or a property and was not on account of capital. It is our view that the reverse premium is on account of capital, and therefore not deductible, because it represents a payment to settle a debt.
2.It remains a question of fact whether all the conditions of paragraph 20(1)(c) are met in determining whether the interest on an assumed debt is deductible and the Department's position on interest deductibility on assumed debts was addressed in our response to Question 3 of the 1992 Conference Report round table and Question 3 of the 1992 Corporate Management Tax Conference round table.
In this particular situation, Co. C does not appear to have assumed indebtedness of Co. A as part of the purchase price of an asset acquired from Co. A, accordingly the interest would not be deductible.
3.No deduction.
4.It seems that the amount of accrued interest and the reverse premium received by Co. C would likely be included in its income in full in the year of receipt either under section 9 or as an inducement payment received in accordance with paragraph 12(1)(x) of the Act.
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