2 September 1998 External T.I. 9807375 - EVENT OF FAILURE OR DEFAULT

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: event of failure or default

Position: general comments

Reasons:

XXXXXXXXXX 							980737
B. Kerr

Attention: XXXXXXXXXX 

September 2, 1998

Dear Madam:

Re: Subparagraph 212(1)(b)(vii)

This is in response to your letter of March 23, 1998, concerning the words “event of a failure or default” as used in clause 212(1)(b)(vii)(C) of the Income Tax Act (the “Act”).

You have described a situation involving a loan facility where the lender wants to ensure that it is protected from fluctuations in the U.S. dollar principal amount relative to the Canadian dollar borrowed amount. For example, if the borrowing is in Canadian dollars, it is a specific event of default under the terms of the loan facility if, at any time after the time of the borrowing, the amount borrowed in Canadian dollars exceeds 110% of the equivalent amount of U.S. dollars at the time of the borrowing. If such event of default occurs, the borrower is obliged to immediately repay the excess amount.

Our Comments

Paragraph 15 of Interpretation Bulletin IT-361R3 states that an “event of failure or default” under the terms of a loan agreement is one that has commercial reality, is beyond the control of the lender and is therefore not contrived. Such an event that occurs as a consequence of an act by a person or persons who are not party to the loan agreement is usually not considered a failure or default under the terms of the loan agreement. In interpreting the phrase “event or default under the said terms of agreement”, it is recognized that lenders need to protect their loans and, in this regard, would include any event which places one of the parties in breach of the undertaking or guarantees in the agreement. Usually, if the borrower fails to meet the repayment programs or undertakes actions which materially increase the lender’s risk, the lender may demand repayment in full.

The Department commented on a similar situation involving commodity prices at the 1986 annual conference of the Canadian Tax Foundation where it was stated in response to question 12 of the Revenue Canada Round Table, that it is the Department’s position that events that are the consequence of an act by persons not party to the agreement do not represent an event of failure or default for the purpose of clause 212(1)(b)(vii)(C) of the Act. A requirement to pay more than 25 percent of a loan within five years because of a change in economic conditions would represent a requirement to pay “under any circumstances”

In our view, the position as expressed at the 1986 Round Table would also apply to the situation you describe.

We trust that these comments will be of assistance.

Yours truly,

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