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:
An innovative instrument is a debt instrument that constitutes Tier 1 capital to a bank or federally regulated trust and loan company. Would a requirement for a mandatory conversion provision or other loss absorption feature threaten the interest deductibility of such an instrument?
Position:
Yes. The presence of a mandatory conversion provision, or other loss absorption feature, would likely result in the debt constituting something other than "borrowed money" for the purposes of paragraph 20(1)(c).
Reasons:
A debt is "borrowed money" only if there exists a borrower\lender relationship between the debtor and creditor. Such a relationship, in turn, exists if the "lender" will be able, at some given time, to enforce repayment of the amount advanced, either by receiving the cash itself or property having an equal value. A mandatory conversion feature or other loss absorption feature could permit a bank to repay holders of its innovative instruments less than the amount advanced.
xxxxxxxxxx 992477
R. Maley
Attention: xxxxxxxxxx
October 5, 1999
Dear XXXXXXXXXX:
Re: OSFI Tier I Capital Principles
This is in reply to your letter dated September 13, 1999 in which you requested our views as to whether the criteria for structuring innovative instruments set out in OSFI's "Interim Appendix" of July 1999 poses any issues in respect of interest deductibility. An innovative instrument is a debt instrument that constitutes Tier 1 capital to a bank or federally regulated trust and loan company.
Your particular concern with the criteria for innovative debt instruments is the requirement that they be able to absorb losses of the bank without triggering the cessation of ongoing operations or the start of insolvency proceedings. A mandatory conversion of the debt instrument to preferred shares of the bank in the event of specified loss circumstances would be an example of such a loss absorption feature. You have questioned whether such a loss absorption feature would be sufficient to constitute the debt something other than “borrowed money" for the purposes of paragraph 20(1)(c) of the Income Tax Act.
We have reviewed the Interim Appendix and are of the view that the presence of a mandatory conversion provision, or other loss absorption feature, would likely result in the debt constituting something other than "borrowed money" for the purposes of paragraph 20(1)(c). In that event, an amount payable by the bank on the instrument would not be deductible even if the amount is interest for tax purposes. At law, a debt is "borrowed money" only if there exists a borrower\lender relationship between the debtor and creditor. Such a relationship, in turn, exists if the "lender" will be able, at some given time, to enforce repayment of the amount advanced, either by receiving the cash itself or property having an equal value. Our reading of the Interim Appendix suggests that the loss absorption features at issue would permit a bank to repay holders of its innovative instruments with (depending on the structure of the 1055 absorption feature) shares, cash or other property having a fair market value less than the amounts advanced under the instruments.
Thus, while it would be necessary to examine the terms of any particular instrument, our view is that the presence of a mandatory conversion provision as described in the Interim Appendix would likely result in amounts payable by the bank on the instrument not being deductible even if the amounts otherwise qualify as interest for the purposes of paragraph 20(1)(c).
If you would like to discuss this matter further, please feel free to contact Robin Maley (613-957-9226) of the Financial Industries Division directly.
Yours truly,
F. Lee Workman
Manager
Financial Institutions
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
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