13 May 2003 External T.I. 2003-0013655 - 18(9.1)

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Whether, a payment (the "Fee") made in the course of a borrowing of money, as consideration for a lender agreeing to charge a borrower a lower interest rate than the borrower could otherwise negotiate with another lender, is a payment made by the borrower in respect of borrowed money as consideration for a reduction in the rate of interest payable such that the Fee would be deductible under subsection 18(9.1).

Position TAKEN:

No.

Reasons FOR POSITION TAKEN:

The payment of the Fee by the borrower to the lender is made in the course of a borrowing of money. The Fee is paid by the borrower to the lender when borrowing such that there is, at the time of the payment of the Fee, no "borrowed money" for which the "rate of interest payable" is being reduced for purposes of subsection 18(9.1).

Accordingly, the Fee is not a payment made by the borrower in respect of borrowed money as consideration for a reduction in the rate of interest payable for purposes of subsection 18(9.1).

XXXXXXXXXX  						2003-001365
P. Diguer
May 13, 2003 

Dear XXXXXXXXXX:

Re: Subsection 18(9.1) of the Income Tax Act (Canada) (the "Act")

This is in reply to your letter dated January 16, 2003, in which you request our views on the applicability of the penalties, bonuses and rate-reduction payments deduction provided in subsection 18(9.1) of the Act in respect of a payment made by a corporation (B Co) to a second corporation (A Co) as a payment for A Co agreeing to pass on the benefit of its ability to borrow at lower rates of interest than B Co thereby reducing the effective interest rate of a borrowing by B Co.

In particular you describe a situation where:

A corporation ("A Co") borrows funds (the "A Co Loan") on a long-term basis from an arm's length lender. A guarantor dealing at arm's length with A Co guarantees the A Co loan throughout its term. The A Co Loan is secured by a mortgage on A Co's assets. Owing to the guarantee and the security pledged, A Co is able to materially increase its credit worthiness and thereby obtain a better interest rate than would otherwise be available.

A Co pays a one-time guarantee fee at the time of closing to the guarantor under terms which, in the event of a default by A Co on its debt to the lender, require the guarantor to repay the loan.

A Co will on-lend to B Co on a long-term basis the amount borrowed from the arm's length lender. The market interest that B Co will be able to borrow at will be materially greater than the rate available to A Co. However, B Co will agree to pay an amount (the "Fee") to A Co equal to the guarantee fee paid by A Co to the guarantor in exchange for A Co agreeing to pass on the benefit of A Co's lower interest rate on the A Co Loan by charging B Co a reduced interest rate.

At issue is whether the Fee constitutes a payment which is subject to the deduction provided in subsection 18(9.1) of the Act.

Your view

? Subsection 18(9.1) of the Act applies to deem the Fee to be interest in the hands of both B Co and A Co.

? Paragraph 20(1)(e) of the Act does not apply to the Fee because the preamble to the said paragraph provides that it applies only if the amount is not otherwise deductible in computing the income of B Co. Since you concluded subsection 18(9.1) of the Act applies, 20(1)(e) of the Act would not apply.

Our comments

The situation that is described in your letter appears to involve a series of actual completed transactions involving specific taxpayers. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular IC-70-6R5 dated May 17, 2002. Where the particular transaction is completed, the inquiry should be addressed to the relevant Tax Services Office. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which we hope are of assistance to you.

Subsection 18(9.1)

In broad terms, subsection 18(9.1) of the Act treats a payment made to buy down an interest rate or to prepay the principal of a debt obligation as prepaid interest, other than a payment described in the broad exclusionary rules in paragraphs 18(9.1)(a) and (b) of the Act.

Subsection 18(9.1) provides, in part, as follows:

(9.1) Penalties, bonuses and rate-reduction payments

Subject to subsection 142.4(10),where at any time a payment, other than a payment that...

(a)... or

(b)...

is made to a person ... by a taxpayer in the course of carrying on a business or earning income from property in respect of borrowed money or ... (in this subsection referred to as a "debt obligation")

(c) as consideration for a reduction in the rate of interest payable by the taxpayer on the debt obligation, or

(d) as a penalty or bonus payable by the taxpayer because of the repayment by the taxpayer of all or part of the principal amount of the debt obligation before its maturity,

the payment shall, to the extent that it can reasonably be considered to relate to, and does not exceed the value at that time of, an amount that, but for the reduction described in paragraph (c) or the repayment described in paragraph (d), would have been paid or payable by the taxpayer as interest on the debt obligation for a taxation year of the taxpayer ending after that time, be deemed, ... .

(our emphasis added)

At issue is:

(a) whether the Fee constitutes a payment made to A Co by B Co in the course of carrying on a business or earning income from property in respect of borrowed money as consideration for a reduction in the rate of interest payable by B Co on the debt obligation, and

(b) if the Fee is a payment described in (a) above, whether the Fee can, reasonably be considered to relate to an amount that ... would have been paid or payable by the taxpayer as interest on the debt obligation for a taxation year of the taxpayer ending after that time.

Paragraph 18(9.1)(c)

Paragraph 18(9.1)(c) refers to payments made as consideration for a reduction in the rate of interest payable by the taxpayer on the debt obligation.

The payment of the Fee by B Co to A Co is made in the course of a borrowing of money, as consideration for A Co agreeing to charge B Co a lower interest rate than B Co could otherwise negotiate with an arm's length lender. Since the Fee is paid by B Co to A Co when borrowing, there is, at the time of the payment of the Fee, no "borrowed money" for which the "rate of interest payable" is being reduced for purposes of subsection 18(9.1). Accordingly, the Fee is not, in our view, a payment made by B Co in respect of borrowed money as consideration for a reduction in the rate of interest payable.

Moreover, paragraph 18(9.1)(c) of the Act is subject to the two conditions contained in the mid-amble between paragraphs 18(9.1)(d) and (e). First, a payment is generally deductible only to the extent that it may reasonably be considered to relate to an amount that would otherwise have been payable as interest by the taxpayer. This is a question of fact. Second, the payment must not exceed the "value" at that time of an amount that, but for the payment, would have been paid or payable by the taxpayer as interest. This also is a question of fact. Since there is not an amount that would otherwise have been payable as interest by B Co the Fee cannot, reasonably be considered to relate to an amount that ... would have been paid or payable by the taxpayer as interest on the debt obligation for a taxation year of the taxpayer ending after that time for purposes of the mid-amble between paragraph 18(9.1)(d) and (e) of the Act.

Paragraph 20(1)(e)

The CCRA considers that an amount paid to the guarantor of a loan either on a periodic basis during the continuance of the loan, or as a one-time payment at the commencement of the loan incurred in the course of borrowing money and not otherwise deductible is generally deductible under subparagraph 20(1)(e)(ii) of the Act 1 .

However, the CCRA considers that the deduction permitted by paragraph 20(1)(e) or (e.1) is restricted to the taxpayer who enters into a transaction described in paragraph 20(1)(e). If for example, expenses are paid by a parent company on behalf of its subsidiary, in connection with the issuance of shares by its a subsidiary, they are not deductible by the parent company under paragraph 20(1)(e). However, provided such expenses are reimbursed by the subsidiary to the parent, and are reasonable in the circumstances, they would be deductible by the subsidiary. 2

The legal relationship between A Co and B Co is not mentioned in your letter. However, if A Co pays an amount to a guarantor of the loan as a one-time payment made in the course of borrowing money and the amount otherwise meets the requirements of paragraph 20(1)(e) of the Act, the said payment by A Co would likely be deductible by A Co under subparagraph 20(1)(e)(ii) of the Act.

However, the Fee paid by B Co to A Co is not a guarantee fee and as such it remains a question of fact as to whether the Fee would be deductible by B Co under subparagraph 20(1)(e)(ii) of the Act.

We trust our comments will be of assistance to you.

Yours truly,

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

ENDNOTES

1 Paragraph 17(d) of Interpretation Bulletin IT-341R3.

2 Paragraph 10 of Interpretation Bulletin IT-341R3.