21 August 1989 Income Tax Severed Letter AC74236 - Security Lending Arrangements

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.

To:  Mr. B.J. Bryson                    From: Financial
Industries
     Acting Director                          Blair P. Dwyer
     Current Amendments and                   (613) 957-2744
      Regulations Division

Subject: Security Lending Arrangements

File:7-4236

This is in reply to your memorandum dated August 14, 1989, in which you asked for our views on two matters arising out of the proposed legislation in Bill C-28 concerning security lending arrangements.

Proposed Paragraph 260(8)(a)

The first question relates to the following hypothetical situation:

Pursuant to a securities lending arrangement, a Canadian resident (the "Securities Borrower") borrows from a non- resident (the "Securities Lender") a five-year debt obligation described in subparagraph 212(1)(b)(vii) of the Act. The Securities Borrower provides cash collateral equal to 95% of the fair market value of the borrowed security.

Your wish to know whether proposed paragraph 26)(8)(a) will apply to exempt interest compensation payments made by the Securities Borrower to the Securities Lender from Part XIII withholding tax.

Our position is that the proposed exemption will not apply in most cases. Proposed paragraph 260(8)(a) merely deems the compensation payment to be a payment of interest on the debt that has been borrowed. In order for the subparagraph 212(b)(vii) exemption to apply, the person making an interest payment must

a) be a corporation resident in Canada;

     b)   deal at arm's length with the non-resident recipient of
          the payment;

c) be the corporation that issued the debt obligation.

The satisfaction of these criteria will depend on the identity of the Securities Borrower. However, it is extremely unlikely that the Securities Borrower will be the corporation that originally issued the five-year debt.

Sale and Return of Debt

The second question relates to the following hypothetical situation:

As part of a securities lending arrangement, a Canadian resident sells a qualified debt security to an arm's length non-resident in exchange for $100. The sale agreement provides that the resident will repurchase the debt from the non-resident at a specific future date for $105.

You wish to know whether

     a)   the difference between $100 and $105 can be regarded as
          interest for purposes of Part XIII of the Act; and 

     b)   the answer to (a) depends on whether the non-resident
          treats the transaction as being on capital or income
          account.

In this case, the lender (or seller) of the security is paying a premium to the non-resident borrower on the repurchase of the security. This is the reverse of the situation described in proposed paragraph 260(8)(b) and, consequently, that provision would not apply.'

We would attempt to apply subsection 214(7.1) to impose Part XIII tax on the $5 payment to the non-resident. However, it is by not means clear that we would succeed. Proposed subsection 260(2) deems the transfer from the resident to the non-resident to be anon-disposition for purposes of the Act. In order for subsection 214(7.1) to apply, the resident must have "assigned or otherwise transferred" an obligation to the non-resident (paragraph (a)). While "assign" and "transfer" are not the same words as "disposition", the meaning of "disposition" is very broad and includes the concepts of "assign" and "transfer". See The Queen v Compagnie Immobiliere BCN Ltee, 79 DTC 5068 (SCC), at p. 5072, in which the court concludes that "disposition" should ge given the "broadest possible meaning".

It is difficult to see how a person can have "assigned or otherwise transferred" a property by means of a transaction

a) that is deemed to be not a disposition; and

     b)   after which the property is deemed to continue to be
          his property.

We also refer to Olympia & York Developments Ltd. v The Queen, 80 DTC 6184 (FCTD), at p. 6193. In this case, the court used th meaning of "disposed" to determine the meaning of its opposite, "acquired". If a court is willing to determine the meaning of a word by reference to its opposite, it may also conclude that a broad word such as "disposition" includes a reference to its included concepts.

Several cases have dealt with deemed control provisions (such as current paragraph 251(5)(b)) and have concluded that those provisions do not prevent an actual controller from continuing to have control: see Yardley Plastics of Canada Limited v MNR, (1966) CTC 215 (Exch); Viking Food Products Ltd. v MNR, 67 DTC 5067 (Exch); and MNR v Fritz Werner Ltd. (1972) CTC 274 (FCTD).

However, the deemed control provisions in those cases extended but not restrict the meaning of control (see Yardley Plastics, at p 221, first sentence of second paragraph). In contrast, proposed subsection 260(2) restricts the meaning of "disposition" by deeming an action that would otherwise constitute a disposition to be a non-disposition.

Proposed subsection 260(2) deems the loaned security to continue to be owned by the resident. Consequently, it is also unclear whether the non-resident can "assign or transfer back" (as described in paragraph 214(7.1)(b) the debt to the deemed owner. Strictly speaking, this subsequent transfer is not a deemed non-disposition. Since it is unclear whether the "transfer back" is described in paragraph (214(7.1)(b), it is unclear whether subsections 214(6) or (7) would apply.

It is doubtful that the $5 premium would be taxable as interest pursuant to subsection 16(1). This provision usually applies only if a sale price exceeds fair market value and is payable over time. In the hypothetical situation, no sale price is paid over time. The $5 premium arises as the result of a time lag between two sales and not a time lag between sale and payment.

Our response does not depend on whether the non-resident treats the transactions on income or capital account.

General

If you have any questions on the above, please contact Blair Dwyer at 957-2744 Director Financial Industries Division Rulings Directorate