5 November 2002 External T.I. 2002-0167075 - REGULATION 7000

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:

1) Escalating GIC - paid on a yearly basis - is it prescribed?

2) Examples of four types of prescribed debt obligations

Position TAKEN:

1) YES
2) Examples given- General description

Reasons FOR POSITION TAKEN

12(9), 7000(1)(c), (7000(2)(c.1):

12(4) 12(9) regulation 7000(1)(a), (b), (c), (d)

2002-016707
XXXXXXXXXX C. Tremblay, CMA
957-2139
November 5, 2002

Dear XXXXXXXXXX,

Re: Section 7000 of the Income Tax Regulations (the "Regulations")

This is in reply to your letter of October 1, 2002, wherein you asked for an interpretation of paragraphs 7000(1)(a), (b), (c) and (d) of the Regulations.

Section 7000 of the Regulations defines the types of debt obligations that are "prescribed debt obligations" for purposes of subsection 12(9) of the Income Tax Act (the "Act") and mandates specific accrual rules for such instruments. Under section 7000 of the Regulations, there are four mutually exclusive types of debt obligations included in the definition of a prescribed debt obligation. They are listed as follows:

1) Paragraph 7000(1)(a) of the Act describes a debt obligation where no interest is stipulated to be payable thereon. Examples of such obligations are "deep discount bonds" with no stipulated interest and issued for a price that is significantly less than its value on maturity.

2) Paragraph 7000(1)(b) of the Act describes a debt obligation of an issuer where more than one investor holds an interest in that obligation and payments of principal and interest do not flow in equal proportions to each investor under the obligation. Examples include a bond where the coupons have been removed and sold separately from the principal (i.e. stripped bonds).

3) Paragraph 7000(1)(c) of the Act describes a debt obligation which provides for increasing yearly interest payments. Examples include increasing rate guaranteed investment certificates and step-up or escalating bonds. An escalating Guaranteed Investment Certificate (a "GIC"), which calls for payments of 3% in the first year, 4.75% in the second, and 6% in the third, would be so identified.

4) Paragraph 7000(1)(d) of the Act identifies a debt obligation on which the amount of interest varies according to a contingency. An example includes a debt obligation that contains an amount payable that is based on a contingency that is fulfilled after the year.

In our view, an escalating GIC, which has increasing interest rates throughout its term to maturity, is a prescribed debt obligation. Accordingly, the special rules contained in section 7000 of the Regulations and subsection 12(9) of the Act, result in a deemed calculation of accrued interest for the purposes of subsection 12(4) of the Act. This deemed accrued interest is essentially interest calculated on a yield to maturity basis and not the amount paid on the contract basis.

Where a prescribed debt obligation is described under paragraph 7000(1)(c) of the Regulations, that is where it can be determined, at the time the taxpayer acquired an interest therein, that the maximum amount of interest payable thereon in a year ending after that time is less than the maximum amount of interest payable thereon in a subsequent year (for example, an escalating GIC) the interest is calculated according to paragraph 7000(2)(c.1) of the Regulations. If the debt obligation is held to maturity, the total interest actually paid on the investment and the total interest reported for income tax purposes will be the same. Where the obligation is not held to maturity or if the taxpayer dies before maturity of the obligation, it is possible that interest income reported for income tax purposes will exceed the interest income actually paid. In such cases the excess interest income reported for tax purposes can be deducted under subsection 20(21) of the Act.

From a policy perspective, the rules in section 7000 of the Regulations provide certainty with respect to the determination of accrued interest in circumstances where, because of the nature of the instrument, it would be difficult or unclear how to make such a determination. As to a debt obligation described in paragraph 7000(1)(c) of the Regulations and calculated according to paragraph 7000(2)(c.1) of the Regulations, the rule can be considered a "leveling" of the interest rates over the term of the instrument.

Any change to the rules regarding the determination of accrued interest in respect of step-up or escalating GIC's would require an amendment to the Act. Should you wish to make submissions regarding such a change, you should write to the officials in the Tax Policy and Legislation Branch at the Department of Finance, L'Esplanade Laurier, 140 O'Connor Street, Ottawa, Ontario, K1A 0G5, who are responsible for amendments to the Act.

We trust that these comments will be of assistance.

Yours truly,

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