16 March 1996 External T.I. 9532295 - CONVERTIBLE DEBENTURE

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.

									5-953229
XXXXXXXXXX							(613) 957-8953

Attention: XXXXXXXXXX

March 13, 1996

Dear Sirs:

This is in response to your letter dated November 28, 1995 wherein you request our opinion as to whether the transfer of a convertible debenture (of a corporation resident in Canada in shares of that corporation) by a non-resident to a person resident in Canada could give rise to double taxation under Parts I and XIII of the Income Tax Act (the "Act").

You indicated in your letter that it would appear that such transfer would give rise to Part XIII tax on deemed interest pursuant to subsection 214(7) of the Act and Part I tax on the taxable capital gain realized on the disposition of the convertible debenture. You also noted that no treaty relief would appear to be available in such circumstances.

Your concern is due to a technical opinion issued by our department1 concerning whether the phrase "real property situated in the other Contracting State" contained in paragraph 3 of Article XIII of the Canada-U.S. Tax Convention (the "Treaty") includes, in the case of real property situated in Canada, an option in respect of a share of a company the value of whose shares is derived principally from real property situated in Canada. The opinion confirmed that in the view of the department the reference in paragraph 3 of Article XIII of the Treaty to a share of a capital stock of a company the value of whose shares is derived principally from real property situated in Canada includes an option in respect of such a share. Consequently, any gain realized on the disposition of the option would be subject to Part I tax in Canada.

You are concerned that this interpretation may give rise to double taxation where a non-resident holds a convertible debenture rather than a share option. You refer to paragraph 3 of Interpretation Bulletin IT-176R2 where it would appear that the department would characterize a convertible debenture as an interest in or option in respect of a share.

You would like a confirmation that the potential for double taxation does indeed arise in the circumstances outlined above. Also, you request our opinion concerning how the double tax problem would be alleviated for domestic tax purposes. Finally, you would like to know how the Treaty would apply in such circumstances.

Our comments

We agree that there is a potential for double taxation in such a situation. However, the Department would generally not endeavour to tax under Part I of the Act the capital gain arising from the disposition of a taxable canadian property where subsection 214(7) of the Act is applicable. This assumes that the debenture is not an excluded obligation as defined in subsection 214(8) of the Act. The provisions of subsection 214(7) of the Act are more specific and would apply to deem that a payment of interest has been made.

Such deemed payment of interest would be considered interest for the purpose of the Treaty by virtue of the definition of interest provided for in paragraph 4 of Article XI of the Treaty. Consequently, the deemed payment of interest could be taxed in Canada but not in excess of 10% of the gross amount of interest by virtue of paragraph 2 of Article XI of the Treaty.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

ENDNOTES

1 We assume you are referring to opinion # 5-942640 issued to your firm on February 10,1995.