29 October 1996 External T.I. 9626325 - BOND OPTIONS

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:

Option sold giving the right to acquire interest-bearing bonds with interest rate higher than the market rate. Option is on capital account.

1.Does section 49 apply only and not paragraph 12(1)(x) and subsection 9(1)?

2.Is paragraph 20(1)(c) applicable?

Position:

1.Section 49 applies to a bona fide option. In a factual situation, paragraph 12(1)(x) could apply depending on the particular facts and circumstances.

2.20(1)(c) could not apply to the portion of the interest that may be considered as a compensation for the premium paid on the acquisition of the option.

Reasons:

									5-962632
XXXXXXXXXX							G. Martineau

Attention: XXXXXXXXXX

October 29, 1996

Dear Sirs:

Re: Bond Options

This is in reply to your letter of August 1, 1996, in which you request our opinion on the tax treatment of the consideration received by a taxable Canadian corporation (the "Issuer") on the issuance of options giving the holder of the option the right to acquire interest-bearing bonds of the Issuer at a future date for an exercise price equal to the face amount of the said bonds. The issuer receives a premium since the bonds bear an interest rate higher than the market rate at the time the options are issued.

It appears that your enquiry relates to specific transactions, either proposed or completed. Where a transaction is proposed, confirmation of the tax implications arising therefrom should be sought by way of an advance ruling request submitted in the manner set out in Information Circular 70-6R2. Where a completed transaction is involved, the enquiry should be addressed to the relevant Tax Services Office. We offer, however, the following general comments.

Where the consideration received by the issuer of a bona fide option to acquire bonds to be issued by it is on capital account, the granting of the option does not give rise to a capital gain pursuant to subsection 49(1) of the Act. Subsection 49(2) of the Act specifies that the issuer corporation is deemed to have disposed of capital property and the proceeds from granting the option is treated as a capital gain if the option expires. The exercise of an option for the acquisition of bonds does not result in a taxable event for the issuer corporation.

Generally, interest not in excess of a reasonable amount is deductible pursuant to paragraph 20(1)(c) of the Act where it can be shown that the borrowed funds are being used to earn income from a business or property. Whether the interest rate on a particular debt is a reasonable rate of interest and results in a reasonable amount of deduction for the purposes of paragraph 20(1)(c) of the Act is a question of fact. However, where a debt is issued upon the exercise of an option in the circumstances described above, the Department will examine if the excess of the interest rate over the market rate is compensation for the premium paid on the acquisition of the option and, consequently, not deductible pursuant to paragraph 20(1)(c) of the Act.

Whether or not subsection 245(2) of the Act applies is a question of fact and cannot be fully considered in a general inquiry. However, it does appear that a tax benefit within the meaning of subsection 245(1) of the Act could arise out of the described series of transactions.

The above comments reflect an expression of opinion only and are not meant to restrict the application of the Act to paragraph 20(1)(c) in a factual case. Moreover, they are not binding on the Department, as explained in paragraph 21 of Information Circular 70-6R2. We trust, however, that they are of assistance.

Yours truly,

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