Callable step-up notes are not investment contracts.
Comparison of extendible and callable step-up notes (pp.1127-8)
An Extendible Step-Up Note offers essentially the same economics as a Callable Step-Up Note, but rather than having a maturity date with optional redemption dates prior to that time, an Extendible Step-Up Note has an initial maturity date, with the option for the issuer to extend the maturity date on the extended maturity dates up to a final maturity date….
Extendible (unlike callable) note not within Reg. 7000(1)(c) (p. 1128)
[A] Callable Step-Up Note will meet the criteria set out in paragraph 7000(l)(c) of the Regulations as it can be determined, at the time that the note is (acquired, that the maximum amount of interest payable thereon in a year will be less than the maximum amount of interest payable in a subsequent year. [fn 6: This characterization has recently been confirmed in …2003-0006645…] However, an Extendible Step-Up Note should not be considered a prescribed debt obligation for these purposes, as a holder of an Extendible Step-Up Note has no present right, at the time that the note is acquired, to any interest beyond the initial maturity date or extended maturity date, as the case may be….
Example of application of Reg. 7000(2)(c.1) (p. 1129)
Using a simple example, assume an investor acquires a three-year Callable Step-Up Note that is redeemable at the option of the issuer at the end of each year and that bears interest of 6% in year 1, 8% in year 2.and 10% in year 3. Here, paragraph 7000(2)(c.1) will result in a 7.899% accrual rate for each year that certain investors hold the note.
PDO rules do not apply to individuals (p. 1129)
[P]aragraph (i) of the definition of "investment contract" provides that where a holder includes interest (and amounts in lieu of interest) in computing its income accrued on a debt obligation on at least an annual basis, the debt will not be an investment contract. The terms of a Callable Step-Up Note (as well as a non-callable "Step-Up Note" or "Escalating Rate Note") generally provide that the annual stipulated interest will be paid semi-annually each year (such that the annual stipulated interest will be included in income on a received or receivable basis). Consequently, a Callable Step-Up Note (as well as a non-callable "Step-Up Note" or "Escalating Rate Note") should not be considered to be an investment contract and therefore subsection 12(4) should not apply to an individual holder….
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