14 November 1991 Internal T.I. 9117467 F - Interest Expense

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.

7-911746

24(1)

We are replying to your memorandum dated June 25,1991 requesting our comments with respect to your position that interest expense with respect to money borrowed by  24(1)   (the "Company" to redeem common shares held by the   24(1)    is not deductible as the funds were not used to earn income from a business or property.

The pertinent facts as we understand them are as follows

1.     

24(1)2.

3.     

4.     

24(1)

Rulings Directorate analysis and opinions

A.        To the extent that the   24(1)   redemption price paid by the Company to the Bank exceeds the nominal amount of paid-up capital in respect of the shares redeemed, subsection 84(3) of the Act deems the excess to be a dividend paid by the company and received by the Bank.  The  24(1)   payment cannot be characterized as a financing cost.  The difference between the 24(1)    paid and the amount of the deemed dividend is a return of capital and not deductible.

B.        It is the Department's position that interest paid on money borrowed to pay deemed dividends ic deductible only to the extent that the Company has accumulated earnings at that time. (We refer you to the answer to question 10 on page 10:15 of the report of the 1987 CORPORATE MANAGEMENT TAX CONFERENCE.)

C.        On the assumption that the Company does not have any accumulated earnings at the time of the redemption of the shares held by the Bank and that the deemed dividend pursuant to subsection 84(3) is the full amount of the  24(1)   payment, it is our opinion that interest on the money borrowed the amount of the deemed dividend is not deductible pursuant to paragraph 20(1)(c) of Act.

24(1)It is our opinion that the deemed dividends received by the Bank cannot be deducted by the Bank under 112(1) of the Act as in our view the Common Shares on which the deemed dividends were paid qualify as term preferred shares pursuant to the definition of term preferred share in 248(1) of the Act. Subsection 112(2.1) of the Act does not permit a bank to deduct under 112(1) a dividend received on a share that was a term preferred share acquired by the specified financial institution in the ordinary course of its business.

In Our opinion the Common Shares of the Company acquired by the Bank in    24(1)   24(1)     and at the time of redemption were term preferred shares because they met the following conditions set out in the definition of term preferred share in 248(1):

a)        The Common Shares are shares issued after November 16, 1978.,

b)        Under the terms of any agreement the owner of the share may cause the share to be redeemed acquired or cancelled ( a(i) of the definition) or the issuing corporation may be required to redeem acquire or cancel the share ( a(ii) of the definition).

It seems obvious to us that at the time the Bank exercised the option and acquired the Common Shares of the Company that there was agreement between the Company and the Bank that the shares would be redeemed for 24(1)  immediately after the shares were acquired by the Bank. This was undoubtedly a condition imposed by the Bank during the negotiations leading to the exercise of the option and the redemption for  24(1)  The terms of common shares do not normally make them redeemable or retractable.  Consequently the Company's desire to refinance its debt with another lender other than the Bank allowed the Bank to negotiate the redemption and the very favourable redemption amount of   24(1) before it even exercised the option.  The agreement to acquire the shares and the concurrent requirement to redeem them are clearly evident from the facts set out above.  It is reasonable to conclude that at the time of exercising the option the Bank could require the Company to redeem the Common Shares and that makes them term preferred shares by definition. 24(1) According to the Bank Act "a bank shall not own shares in a Canadian corporation in any number that would, under the voting rights attached to the shares owned by the bank, permit the bank to vote more than ten per cent of the total votes that could, under the voting rights attached to all shares of the corporation issued and outstanding, be voted by the holders thereof.

24(1)

We apologize for the delay in replying to to your memorandum which was caused by a combination of priority workload and other circumstances beyond our control.

DirectorFinancial Industries DivisionRulings Directorate