28 June 1989 Income Tax Severed Letter AC73812 - Whether Discounts Are the Equivalent of Interest

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.

January 28, 1989

To:  Montreal District Office           From: Head Office
     J.P. Lavigne                             Financial Industries 
     Chief of Audit                             Division
                                              T. Murphy
                                              613-957-2747
     Attention: R. St. Louis                  
                Audit Review Section
                5th Floor

Subject: Whether discounts are the equivalent
         of interest
         Paragraphs 20(1)(c) and 20(1)(f) of 
         the Income Tax Act (the "Act")

We are writing in reply to your memorandum dated April 5, 1989, including the additional information forwarded to us on May 25, 1989, concerning the above captioned matter.

Facts

Our understanding of the facts is as follows:
                        24(1)24(1)24(1)            Opinion

24(1) has not provided a written submission to support its position that the discounts are interest and thus deductible under paragraph 20(1)(c). From meeting and discussions held with 24(1) representatives, you have ascertained that their principal argument is based on the comments made in paragraphs 3 and 24 of Interpretation Bulletin IT-114 . 24(1) has also pointed out that on page 22 of the prospectus regarding the 7% debentures, the investors were advised that the discount may be regarded as interest. 24(1) also referred to the following court cases as support for their position: Arthur Cohen v MNR, 57 DTC 1183 (Ex. Ct.) and No. 593 v MNR, 59 DTC 104 (T.A.B.).

District Office Opinion

In your opinion 24(1) is incorrect in claiming that the discounts are equivalent to interest and thus deductible under paragraph 20(1)(c). You feel that paragraphs 18(1)(f) and 20(1)(f) are applicable and that the discounts will only be deduction to the extent permitted by subparagraph 20(1)(f)(ii) 24(1)

                                              Your reasons are as
follows:

     a.   The discount does not have the characteristics of
          interest as set out in Brenda J. Miller v Her Majesty The
          Queen, 85 DTC 5354 (F.C. - T.D.).

     b.   You do not believe that the interest rate on either the
          7%  debentures or the 6 3/4% dual currency issue is
          substantially lower than the market rate of interest on
          the 7% debentures and the 6 3/4% dual currency issue is
          8.15% and 7.9% respectively.

     c.   You feel that the intent of paragraph 20(1)(f) is to
          ensure that both the lender and borrower receive
          consistent tax treatment.  You note that while in the
          case of the dual currency bond issue this is a mute point
          as all the investors are non-residents exempt from
          withholding tax under subparagraph 212(1)(b)(vii), it is 
          important in the case of the 7% debentures as all of the 
          investors are Canadian residents.  In your opinion,     
          notwithstanding that the investors were cautioned on page 
          22 of the prospectus regarding the 7% debentures that the 
          discount may regarded as interest by the Department, all 
          investors will treat the discount as a capital gain.

d. Paragraph 11 of Interpretation Bulletin IT-446 states:

          "The rules in paragraphs 18(1)(f) and 20(1)(f) apply to
          a taxpayer whose business consists of, or includes the
          lending of money, as well as to other taxpayers."

Our Opinion

We agree with you that the discounts on the 7% debentures and the 6 3/4% dual currency bond issue are not interest for purposes of the Act.

With respect to paragraph 3 of Interpretation Bulletin  IT-114
, we
have reviewed both the Cohen and No. 593 cases referred to by     
     24(1)       representatives.  In the absence of any evidence
to support the fact that the 7% debentures and the 63/4% dual
currency bond issue carried an interest rate substantially lower
than the market rate at the time of issue, we are unable to see how
these cases support     24(1)    opinion that the
discounts meet the criteria specified in paragraph 3 of
Interpretation ulletin  IT-114
.

Please note that your assumption that the Canadian investors will treat the discount as a capital gain is not a factor influencing our decision.

We confirm that paragraphs 18(1)(f) and 20(1)(f) apply to all taxpayers including those whose business consists of the lending of money. These paragraphs apply of course only to discounts that are not regarded as the equivalent of interest.

Other items

Should        24(1)      present additional evidence which results
in your accepting that the discounts are the equivalent of
interest, please note that the Department's position is that the
discount must be deducted using a simple-compound interest method
rather then a straight line calculation.  Since paragraph 20(1)(d)
allows a deduction for compound interest only when it is paid, a
substantial portion of the discount would be deductible only on
payment.  (You may wish to refer to the article written by Arthur
Scace and Michael Quigley, "New Developments in Debt Financing",
82CR 579, at pp. 598-600.)

We hope our comments are of assistance to you. Should you have any questions, please contact T. Murphy. R.J. Kauffman

Chief Leasing & Financing Section Financial Industries Division Rulings Directorate