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:

Securities lending Arrangement - General inquiries.

Position TAKEN:

General response to questions involving transactions subject to section 260 and transactions outside of s.260.

Reasons FOR POSITION TAKEN:
	Administrative position and technical 	interpretation.

		942771
XXXXXXXXXX	S.J. Tevlin

Attention: XXXXXXXXXX

April 24, 1995

Dear Sirs:

Re: Securities Lending Arrangement ("SLA")

We are writing in response to your letter dated October 26, 1994, wherein you requested our opinions with respect to certain situations involving SLA's between both related and unrelated parties. We apologize for the delay in replying to your request.

Background

In a SLA, qualified securities (as defined in subsection 260(1) of the Income Tax Act (the "Act")) are lent or transferred from one party (the "lender") to another person with whom the lender deals at arm's length (the "borrower") and arrangements are in place such that the borrower can reasonably be expected to return the lent security (or an identical security) to the lender at a later date. The arrangement is such that the lender's risk of loss or opportunity for profit in respect of the loaned security is not changed in any material respect. The securities will be registered in the borrower's name and the borrower will be entitled to receive any interest or dividends that are paid by the issuer. As part of the SLA the borrower will agree to pay the Lender compensation equal to any interest or dividends that would have been received by the lender on the securities lent ("compensation payment"). The borrower will often have to pledge security ("collateral") such as cash or a bank letter of credit in favour of the lender to secure the return of the securities to the lender. The lender would be named agent of the borrower with respect to the collateral and collect interest or dividends (if any) on the borrower's behalf and remit same to the borrower. Usually, the borrower pays the lender a fee ("lending fee") in consideration for entering into the arrangement.

With respect to your letter as it pertains to SLA's, we offer the following general comments.

Comments

1. Section 260 of the Act will not apply to transactions between parties dealing at non-arm's length. Whether participants are not at arm's length is a question of fact.

2. If section 260 of the Act does not apply, we would expect that the loan of the securities to the borrower results in a disposition of the securities by the lender at fair market value and the acquisition by the borrower at fair market value on the date the securities are transferred to the borrower. Where the consideration given by the borrower for the shares consists of an obligation to return the shares that obligation would have a value equal to the fair market value of the shares transferred at the time the shares are acquired. On the transfer the lender simultaneously acquires a right to reacquire the shares that has a cost equal to its proceeds of disposition of the shares.

3. When the non-arm's length borrower returns the shares to the lender, it disposes of them for proceeds equal to the fair market value of the shares on the date of the transfer, resulting in a gain or loss equal to the change in market value of the shares during the period of the loan. Similarly, the obligation to return the shares is extinguished for an equal amount. The borrower will realize a gain or loss on the settlement of the obligation equal to the difference between the value of the shares on the date of the loan and the repayment date. Where the borrower realizes a gain as a result of a decline in the value of the security between the time it was borrowed and the date that it is returned to the lender, this gain would be viewed as business income of the borrower assuming the loan was made in the ordinary course of its business.

4. On the return of the shares, the non-arm's length lender will acquire the shares at a cost equal to their fair market value on the date they are transferred back and will dispose of its right to reacquire the shares for proceeds of an equal amount, resulting in a gain or loss on settlement of the right to reacquire the shares equal to the change in value of the shares during the term of the loan. Assuming the loan is made in the ordinary course of its business, this gain or loss would be business income of the lender.

5. Where the transaction is a SLA, subsection 260(5) of the Act provides that a compensation payment received in lieu of a taxable dividend will be treated as taxable dividend to the recipient if the following criteria are met:

(a) The compensation payment must be received under a SLA as compensation for a taxable dividend paid on a share of the capital stock of a public corporation and the share must be a "qualified security";

(b) The payer of the compensation payment must be one of the following persons:

(i) a person resident in Canada who made the payment in the course of an SLA;

(ii) a non-resident person who made the payment in the course of carrying on business in Canada through a permanent establishment; or

(iii) a provincially registered securities dealer (as defined in the June 23, 1994 draft amendments) who is resident in Canada, where the amount is paid by such person in the ordinary course of the business of trading or dealing in securities carried on by that person.

Otherwise, such compensation payments will be ordinary income to the lender.

6. As to whether subsection 212(1) of the Act would apply to any payment made by a Canadian borrower to a related non-resident lender would be a question of fact.

7. Compensation payments that are deemed to be dividends will be deductible by the borrower on the following basis (based on the June 23,1994 draft amendments):

i) if the borrower is not a registered securities dealer, no deduction is allowed, subject to iii) below;

ii) if the borrower is a registered securities dealer, 2\3 of the compensation payment is deductible, subject to iii) below; and

iii) if the loan is part of a dividend rental arrangement, the compensation payment is fully deductible under S.260(6.1) to the extent of the lesser of (i) the amount of the payments to the lender that are deemed to be a dividend, and (ii) the amount of dividends received on the borrowed shares that are not deductible under S.112(1) by virtue of S.112(3).

8. We are of the opinion that where qualified securities are borrowed from an arm's length person such that the loan qualifies as an SLA, notwithstanding that the lender is deemed by subsection 260(2) of the Act not to have disposed of the securities, subsection 260(2) of the Act does not deem the borrower not to have acquired the securities.

9. A lending fee involving non-arm's length participants would not be captured by the deeming provisions of paragraph 260(8)(b) of the Act. As a result we do not feel that these amounts could be properly classified as interest. Instead, the lending fee would either be subject to tax pursuant to subparagraph 212(1)(d)(i) of the Act for use of property in Canada or will be considered business profits in accordance with the provisions of Article V and VII of the Canada-United States Tax Convention (1980) assuming the lender to be a US resident.

The foregoing comments are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada, Taxation.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch