1 April 1999 Internal T.I. 9833077 - COMPOND VS. SIMPLE INTEREST AND PART XIII TAX

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: Whether interest on an obligation is considered to be paid when a new obligation is issued which principal amount inludes accrued interest on the original obligation

Position: no

Reasons: The new note is issued precisely because the interest has not been paid.

		April 1, 1999

	CALGARY TSO	HEADQUARTERS
J. P. Dunn
	Attention: Gerry Litton	(613) 957-2747
	               International Audit
			983307

Compound vs. Simple Interest and Part XIII Tax

We are writing in response to your memorandum of December 12, 1998 regarding the above-noted subject.

As we understand the situation under review, the corporate taxpayer in question is indebted to its USA parent and interest on this indebtedness is calculated quarterly. The interest is not paid at the time of accrual but is added to the outstanding principal of the indebtedness. In actual fact, the taxpayer adds only 85% of the amount of interest to the old principal balance with the remaining 15% being credited on account of withholding tax payable. We understand that a new note evidencing the new principal amount is executed at that time. In order to avoid the application of section 78 of the Income Tax Act (the "Act"), the accrued interest together with the attendant withholding tax is paid in the second taxation year following the taxation year of the accrual.

Basically, your query concerns whether the accrual of the interest together with the execution of a new note should be considered a payment of that accrued interest. If it can be considered to be a payment of the accrued interest, then the withholding tax should be paid at the time If it cannot be considered to have been paid, then a portion of interest charged on the new principal amount of the loan subsequent to that time should be considered to be on account of compound interest and deductible pursuant to paragraph 20(1)(d) of the Act when paid.

This Division has previously considered this question in somewhat similar circumstances involving the issue of debentures as payment of interest owing in respect of an earlier issue of debentures and whether such additional issue of debentures constituted payment of the interest.

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Accordingly, it is our view that the addition of the accrued interest to the principal amount of the old note and the execution of a new note would not constitute payment of that interest. Because of this, a portion of the interest charged in respect of the new principal amount would constitute compound interest which would be deductible for tax purposes pursuant to paragraph 20(1)(d) of the Act only at the time it is paid. Similarly, any liability for withholding tax in respect of that interest would arise only at that time of payment.

We trust that this is the information which you require.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate

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