4 August 1999 External T.I. 9908885 - TOTAL RETURN SWAPS

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:

1. How do you measure whether a borrower enjoys all of the income derived from "money" which has been lodged as collateral under a security lending arrangement as required under paragraph 260(8)(a)?

2. Should the deemed fee in paragraph 260(8)(b) be calculated in the foreign currency or Canadian currency?

Position:

1. OK to use a comparative return on a deposit of similar quantum and duration.

2. Constant currency should be used using constant exchange rates.

Reasons:

1. Borrower does not have access to lender's records to determine the actual return earned on the money.

2. Using different rates of exchange can produce anomalous results.

XXXXXXXXXX 990888
J. P. Dunn
Attention: XXXXXXXXXX

August 4, 1999

Dear Sirs:

Re: Section 260 of the Income Tax Act - Total Return Swaps

We are writing in response to your correspondence of March 30, 1999 wherein you had requested the views of the Department concerning certain aspects of section 260 of the Income Tax Act (the "Act").

Your first query pertains to paragraph 260(8)(a) of the Act and the requirements thereof respecting the exemption from withholding tax with respect to cash collateral provided to a foreign lender of securities by a Canadian borrower. More specifically, you have enquired how, in order to fulfil the requirement of that provision that the borrower must "be entitled to enjoy... the benefits of all or substantially all the income derived from... the money..." such a requirement would be measured and satisfied in the absence of the foreign lender disclosing to the borrower the actual use of and the income derived from the collateral.

We would generally agree with your suggestion that such a measurement could be satisfied by reference to a market determined rate of interest which is equivalent to the rate which could be earned by the Canadian borrower on a deposit of similar quantum as the cash collateral and similar duration of the security lending arrangement.

Your second question is with respect to the calculation of a deemed fee payable by a Canadian borrower to a non-resident lender pursuant to paragraph 260(8)(b) of the Act in circumstances in which the security lending arrangement is transacted in a foreign currency. As you note, the calculation of a deemed fee pursuant to paragraph 260(8)(b) of the Act may be influenced by fluctuations in the Canadian dollar relative to the particular foreign currency during the term of the security lending arrangement. It is our view that the references to the term "money" in paragraph 260(8)(b) of the Act should be construed being a constant dollar amount throughout that provision such that any calculations required therein would all be based upon those same dollars, regardless of whether those dollars are the Canadian dollar equivalent of the foreign currency or the foreign currency itself with the results converted to Canadian dollars at a constant exchange rate.

We trust that this is the information which you require.

Yours truly,

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

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