(d)-(l)

CRA indicated that the capitalization of unpaid interest on a student loan would constitute the payment of such interest if there was a concurrent novation of the loan by way of change of debt under the governing Quebec law – but that the novated loan would be a new loan rather than qualifying as a loan made under the applicable Quebec post-secondary student assistance program.

Debt owing to the taxpayer following an asset sale provided that interest may be added to the principal of the debt, which is what occurred. The Taxpayer considered that it had paid the accrued and capitalized interest each year, and withheld pursuant to s. 212(1)(b) and added the interest, net of withholding tax, to the balance of its debt. Before concluding that the interest payable at the end of the second year on the interest that was not paid to the creditor in the first year would not be deductible under s. 20(1)(c) and would only be deducible under s. 20(1)(d) when paid, CRA found that:

The facts submitted did not show that there was an actual transfer of money, and that the “mere statement that an amount of interest was added to the principal of the original debt does not seem to us sufficient to conclude that there was a … [fresh] loan between the parties.”

It was not established that there was a novation of the existing debt – there was no evidence of intention to novate, and “the mere addition of unpaid interest to an existing debt does not have the effect of terminating the existing obligation and creating a new one.”

Hill was distinguishable on the basis that, here, there was “no evidence that there was any money available to establish a loan of money.”

The exclusion in s. 20(1)(v)(v) for settlement occurring "as part of a series of borrowings or other transactions and repayments" applies where (i) the debt of the taxpayer is settled by the taxpayer transferring assets to a subsidiary in consideration inter alia for an assumption of the debt (with the taxpayer being released) – or (ii) where the debt is not assumed on the asset transfer and the taxpayer instead uses cash consideration received from the subsidiary (funded out of a borrowing by it) to discharge the debt. In the second situation, CRA considers that the subsidiary borrowing is a borrowing occurring as part of the series. It considers that in the first situation, the debt assumption is also caught, without indicating how the quoted word specifically apply.

Canco along with a joint obligor as guarantor (collectively, the “Obligors”), entered into a Credit Agreement which provided that on the occurrence of a change of control, a sale of certain securities to the public or a sale of substantially all of the assets of the Obligors, the Lender would be entitled to receive a “Liquidity Payment,” which was calculated as X% of a formula amount equal to the gross enterprise value of the business of the Obligors minus specified deductions for indebtedness, share subscription proceeds, certain undistributed amounts and certain taxes. Following repayment of the loans in full, the Lender claimed that it was owed a Liquidity Payment, and after arbitration, Canco paid an amount in settlement of all obligations to make the Liquidity Payment.

In finding that this payment was excluded under s. 20(1)(e)(iv.1)(C), CRA stated:

… Rulings has a long-standing position that share value is a “similar criterion”… . [T]o the extent that share price is considered to be a “similar criterion” because it is connected with profitability or similar factors, the same logic should be applicable to “Enterprise Value”. …[Furthermore] it is your view that the Liquidity Payment was used as a substitute for a direct equity investment that the Lender originally wanted but could not acquire.

… The basic parameters of the negotiations were the two different estimates of Enterprise Value. The fact that the parties disagreed on the quantum of Enterprise Value does not mean that the [settlement] Payment was not calculated with reference to Enterprise Value.

…[Conversely] if the Payment’s negotiated nature distances it sufficiently from the Liquidity Payment such that the Payment can no longer be considered to be based on the same factors that underlie the Liquidity Payment, then one is required to consider whether the Payment’s negotiated nature causes it to not be an obligation arising “in the course of” the borrowing under the Credit Agreement.

Question

Three related corporations (Aco, Bco and Cco) are obligated to pay interest at 10% to a financial institution (the "bank") on the net consolidated balances (i.e., bank overdrafts minus cash balances) owing from time to time to the bank, with the company whose cash balance effectively is used by the others in this manner charging a financial services fee of 10% to the others. For example, suppose the respective balances of Aco, Bco and Cco with the bank were: Aco - $100,000 overdraft; Bco - $100,000 overdraft; Cco - $100,000 cash balance. The bank would charge $7,500 to each of Aco and Bco (computed as $150,000*10%*100,000/200,000). Aco would charge a financial services fee of $2,500 to each of Aco and Bco. Would the financial services fee be deductible to Aco and Bco?

Response

After indicating that the fees were capital expenditures, and that there "are arguments for claiming" deductibility under s. 20(1)(e.1), and before referring to the s. 67 limitation, CRA stated (TaxInterpretations translation) that if s. 20(1)(e.1) did not apply, the financial services fees:

could be deducted over five years by virtue of s. 20(1)(e) as they were incurred in the course of borrowings from a financial institution.

The expenses claimed by a partnership in respect of bank borrowings used to make a distribution to its partners include banker's acceptance fees, whose deduction "may" be governed by s. 20(1)(e). After noting that Document 2005-0161661E5 stated that where a deduction of interest would be allowed under s. 20(1)(c) based on a permitted "indirect use" of borrowed funds (i.e. "fill the hole" of capital), a similar permitted use will be available in respect of a deduction claimed under s. 20(1)(e), CRA stated:

However, we do not appear to have yet considered whether the fee that is entitled to the amortized deduction under paragraph 20(1)(e) will be limited and proportionate to the portion of the borrowed funds that are considered to "fill the hole" of capital (as described in the preceding paragraph) or if no proration will apply to such a fee. If you would like us to consider this issue further.

The unamortized amount of approximately $20 would be deductible in future periods by Aco in accordance with the formula in s. 20(1)(e)(iii).

In order to effectively lock in the interest rate on bonds to be issued by the corporation at a future date, it enters into a hedging arrangement under which, on the date of issuing the bond, it will receive or make a cash payment under a "gilt lock" hedge that reflects the change in the price of bonds between the date of entering into the hedge and the date of closing out such hedge. CRA indicated that the cost of such a hedge (if a payment was made thereunder) would not qualify as an issue expense incurred "in the course of" the borrowing.

Position in 2005-01512117 reversed - financing costs will be deductible under s. 20(1)(e) where the indirect use of the funds test under s. 20(1)(c) is satisfied.

Can a subsidiary corporation, D Co, deduct, under s. 20(1)(e), reimbursement payments paid to its indirect parent corporation, A Co, respecting expenses incurred by A Co in connection with the issuance of debentures of A Co? A Co issued debentures to arm's length parties and then lent the proceeds of the debentures to D Co, which used the funds to pay a dividend to its direct parent corporation. CRA stated:

If D Co was required to pay A Co an amount that equalled A Co's issue costs and the reason why D Co made the payment was so that A Co would agree to on-loan the money to D Co, then D Co would not be precluded from deducting its debt financing costs under paragraph 20(1)(e) of the Act since it (D Co) would have incurred a financing expense in the course of a borrowing of money.

Where a borrower borrows money from an unrelated lender and on-lends to corporations within the group, the reimbursement by those other corporations of the borrower's issue expenses will give rise to deductions to them under s. 20(1)(e)(ii), but the amount of the reimbursement will be included in the income of the borrower pursuant to s. 12(1)(x) unless it deducts the reimbursement under s. 12(2.2).

A borrows funds on a long-term basis from an arm' s length Lender at commercial rates of interest negotiated on the assumption that A's indebtedness to the Lender will be guaranteed for the life of the loan by a Guarantor dealing at arm' s length with A and the Lender and that the loan will be secured by a mortgage on A's assets. A pays a one-time guarantee fee at the time of financial closing to the Guarantor under terms, which, in the event of a default by A on its indebtedness to the Lender, require the Guarantor to repay the loan.

CRA indicated that such fee could be deducted in accordance with s. 20(1)(e) provided that it was “incurred in the course of borrowing money used to earn income from a business or property and that it [was] reasonable.”

Issue expenses for special warrants to acquire common shares are deductible under s. 20(1)(e).

"The deduction under subparagraph 20(1)(e)(i) of the Act is clearly only available with respect to costs incurred 'by the syndicate' taxpayer. It is not available to an investor who purchases an interest in the syndicate."

The fact that costs may have been incurred in order to benefit the shareholders of a corporation rather than for the purpose of earning income from a business or property would not preclude their deduction under s. 20(1)(e).

"There is nothing that would restrict the use of paragraph 20(1)(e) of the Act to non-moneylenders. Accordingly, where some moneylenders have elected to utilize 20(1)(e) which provides for a five-year amortization period vs. a GAAP amortization period which might be for a longer period, Audit's decision to accept the five-year amortization period appears reasonable."

A foreign exchange loss realized on the repayment of a U.S.-dollar loan would not be deductible under s. 20(1)(e)(ii). "The losses are really incurred in respect of the repayment of the borrowing and not necessarily in the course of borrowing, thus falling outside the scope of paragraph 20(1)(e)".

"In a 'bought' deal where the amount paid is clearly not a non-deductible discount, in order for an expense to be deductible under paragraph 20(1)(e) of the Act, cheques need not cross. However, the expense must be reasonable and separately identified as an amount paid or payable for the underwriter's services."

Where there is an acquisition of control of a debtor and of its debt followed in the same day by an amalgamation of the debtor and the purchaser, then provided no election is made under s. 256(9), the amalgamation will be considered to occur on the same day and time as specified in the Certificate of Amalgamation. S.80(2) will deem the debt to have been settled or extinguished immediately before the time that is immediately before the amalgamation, with the result that for purposes of s. 20(1)(e)(v) the debt will be considered to have been settled or extinguished in the taxation year of the predecessor ending immediately before the acquisition of control occurred.

S.20(1)(e)(v) does not apply to permit the deduction of unamortized financing costs where only part of the debt is settled or extinguished, e.g., where the taxpayer transfers a 50% interest in a property to a purchaser who assumes 50% of the related indebtedness.

Where a company experiencing financial difficulties has incurred legal fees to arrange new financing or otherwise restructure its affairs, it will depend on the particular facts of the case whether the fees could be considered to be expenses incurred in the course of borrowing money for purposes of s. 20(1)(e).

Expenses involved in negotiating and evaluating a B.C. employee share ownership plan or B.C. employee venture capital plan seem to constitute mere preliminary steps taken prior to the actual issuance of the shares, and do not qualify for deduction.

Expenses incurred by a corporation in the course of issuing warrants of the corporation are not deductible under s. 20(1)(e).

RC now extends the policy expressed in IT-309R to disability insurance premiums. However, where the disability policy is offered by the lender, rather than required by the lender as collateral, those conditions will not be satisfied.

Because of the decision in Antoine Guertin, RC is in the process of reviewing its position on the deductibility of life insurance premiums.

Question

Three related corporations (Aco, Bco and Cco) are obligated to pay interest at 10% to a financial institution (the "bank") on the net consolidated balances (i.e., bank overdrafts minus cash balances) owing from time to time to the bank, with the company whose cash balance effectively is used by the others in this manner charging a financial services fee of 10% to the others. For example, suppose the respective balances of Aco, Bco and Cco with the bank were: Aco - $100,000 overdraft; Bco - $100,000 overdraft; Cco - $100,000 cash balance. The bank would charge $7,500 to each of Aco and Bco (computed as $150,000*10%*100,000/200,000). Aco would charge a financial services fee of $2,500 to each of Aco and Bco. Would the financial services fee be deductible to Aco and Bco?

Response

After indicating that the fees were capital expenditures, and that there "are arguments for claiming" deductibility under s. 20(1)(e.1), and before referring to the s. 67 limitation, CRA stated (TaxInterpretations translation):

[T]here are arguments ... that the above expenses constitute service fees or similar fees ... . In addition, these expenses seem to relate solely to the year. ...[T]here [also] are arguments for claiming that the corporations incur such expenses with a view to borrowing money which they intend to use for the purpose of earning income from a business or property (other than money used to acquire property that would generate exempt income), as these expenses relate to the loans provided by the financial institution.

Significant legal and consulting fees related to a CCAA restructuring which involved debt restructuring. In response to a query as to whether, where "the indebtedness with respect to a specific creditor was terminated as a result of such restructuring process…such expenses can be considered to relate ‘solely to the year' and, therefore, be eligible for deduction pursuant to paragraph 20(1)(e.1)," CRA stated:

Paragraph 20(1)(e.1) of the Act provides that, notwithstanding paragraph 20(1)(e), certain financing expenses that relate only to the year they are incurred are deductible in that year. The fees deductible under paragraph 20(1)(e.1) include standby charges, guarantee fees, registrar fees, transfer agent fees, filing fees, service fees, or any similar fees, provided such fees are not:

• contingent or dependent upon the use or production from property;
• computed by reference to revenue, profit, cash flow, commodity price, or any other similar criterion; or
• computed by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.

If the expenses listed in your submission fulfill the above-mentioned conditions, they may be eligible for deduction under paragraph 20(1)(e.1)….

A business receives a loan from a financial institution that requires the borrower to take out a disability insurance policy to secure the loan. In finding that the premiums would not be deductible to the borrower under s. 20(1)(e.1), CRA stated:

[T]he term "guarantee fee" in paragraph 20(1)(e.1) does not include premiums payable in respect of a disability insurance policy taken out as collateral for a loan repayment.

A Co, a public company, issued interest-bearing debentures to arm's length parties, and on-lent the borrowed money to its "great-grandchild" subsidiary (D Co) at the same interest rate. D Co used these funds to pay a dividend to its immediate parent (C Co), whose amount likely significantly exceeded D Co’s unconsolidated retained earnings. D Co reimbursed A Co for the issue costs and deducted them under ss. 20(1)(e) and (e.1). In finding that the use test in s. 20(1)(e.1)(i) likely was not satisfied, the Directorate noted the application of the indirect use test in Trans-Prairie Pipelines and Penn Ventilator, but stated that the indirect use test could not be applied here since:

There is no jurisprudence that has extended the application of this principle to paragraph 20(1)(e) of the Act [or to paragraphs 20(1)(d) or (e.1) or (f) of the Act].

In response to a query as to whether the fact that the indebtedness of D Co is for a term of XX years would preclude it from deducting amounts under s. 20(1)(e.1), the Directorate stated:

D Co would have to demonstrate that the amount that it wants to deduct related "solely to the year" in respect of which it is seeking the deduction. We have no evidence that this is the case….

A borrows funds on a long-term basis from an arm' s length Lender at commercial rates of interest negotiated on the assumption that A's indebtedness to the Lender will be guaranteed for the life of the loan by a Guarantor dealing at arm' s length with A and the Lender and that the loan will be secured by a mortgage on A's assets. A pays a one-time guarantee fee at the time of financial closing to the Guarantor under terms, which, in the event of a default by A on its indebtedness to the Lender, require the Guarantor to repay the loan. Before indicating that such fee could be deducted in accordance with s. 20(1)(e) provided that it was “incurred in the course of borrowing money used to earn income from a business or property and that it [was] reasonable,” CRA stated:

[P]aragraph 20(1)(e.1) … does not have application because the guarantee fee is paid in respect of the term of the loan rather than with respect to the year in which it is paid.

In response to a query as to the application of s. 20(1)(e.1) to loan placement fees or loan structuring fees, the Directorate stated:

It is our view that a one time fee related to a loan with a term greater than one year, such as a loan structuring fee or loan placement fee, would generally not "... reasonably be considered to relate solely to the year ..." in which the loan was made or the services were provided. Examples of fees which would ordinarily be subject to paragraph 20(1)(e.1) (providing all the requirements are met) include a recurring annual agency fee or commitment fee.

Guarantee fees paid by a financial institution to its parent corporation in respect of loans made to the taxpayer could qualify for deduction under s. 20(1)(e.1).

CRA indicated that a corporation cannot deduct the life insurance premiums it pays to a financial institution on life insurance to secure a line of credit to the corporation where the financial institution is the owner and beneficiary of the policy as there is no assignment of the policy to the financial institution as required by s. 20(1)(e.2).

A taxpayer, who received a loan from a financial institution under a Quebec farm assistance program, acquired a life insurance policy to guarantee the repayment of that loan and, in certain cases, also acquired a disability insurance policy. Would the resulting life and/or disability insurance premiums be deductible in computing the taxpayer's business income, even if the loan is also secured under such program. CRA responded:

Where a taxpayer assigns a life insurance policy as security for a loan and the creditor has a right to receive some or all of the proceeds of the insurance policy in the event of a future event, it is our view that the taxpayer has assigned an interest in the policy to the creditor. However, a loan granted under the (the program] … is guaranteed, in some respects, by the Farm and Forestry Loan Insurance Fund (the "Fund"). … [W]e understand that what is guaranteed by the Fund is different from what is covered by the life and disability insurance policies purchased from the financial institution. Consequently, we are of the view that the fact that another organization, such as the Fund, guarantees other aspects of the loan should not automatically prevent the taxpayer from deducting life insurance premiums that otherwise satisfy all the other conditions for the application of paragraph 20(1)(e.2).

With respect to premiums payable under a disability insurance policy required by the financial institution, their deduction is also prohibited by paragraph 18(1)(b) because they are capital expenditures. Furthermore, since those premiums are not covered by paragraph 20(1)(e.2), or any other provision of the Act, those expenses are not deductible in computing the taxpayer's business income.

A corporation transferred an interest in a life insurance policy to a restricted financial institution to secure a line of credit, that was only used for some months during the year. How is the deductible amount under s. 20(1)(e.2) calculated? In the course of a general response, CRA stated:

The use of the words "in respect of the year" as used in the preamble of paragraph 20(1)(e.2) ensures that at any time in respect of the year that a taxpayer owes an amount on a line of credit, paragraph 20(1)(e.2) will allow the deduction of a portion of the lesser of the premiums payable by the member for the year under the life insurance policy or the NCPI. This portion must be an amount that can reasonably be considered to relate to the outstanding amount of the line of credit and not the available credit. …

In the situation you described, if the NCPI is lower than the premiums payable, it does not seem reasonable to conclude that the total amount of the NCPI for the year would be deductible by virtue of paragraph 20(1)(e.2) in computing the income of the corporation.

Premiums paid by a parent corporation on a life insurance policy owned by it and assigned as security for a loan made to its subsidiary by a restricted financial institution are not deductible in computing its income pursuant to s. 20(1)(e.2), as it is not the borrower.

A business receives a loan from a financial institution that is 100% guaranteed under a government program, but the lender nonetheless requires the borrower to take out a life or disability insurance policy to secure the loan. Are the premiums paid by the borrower deductible to it? CRA stated:

A premium payable pursuant to a life insurance policy or a disability insurance policy that complies with paragraph 18(1)(a) is, in our view, not deductible under paragraph 18(1)(b). …

[T]he fact that a government agency guarantees other aspects of the loan should not in itself prevent the taxpayer from deducting life insurance premiums that otherwise satisfy the other conditions for the application of paragraph 20(1)(e.2). …

[P]remiums payable by virtue of a disability insurance policy required by the financial institution … are not covered by paragraph 20(1)(e.2) or any other provision of the Act and are not deductible in computing the taxpayer's business or property income.

Where the life insurance coverage under an assigned policy is $500,000 and the average balance owing under the borrowing is $200,000, the amount deductible under s. 20(1)(e.2) is limited to 40% of the lesser of the premiums payable and the net cost of pure insurance under the policy for the year. Furthermore, the assignment must represent a genuine requirement of the borrowing.

In response to a query as to whether the taxpayer would be entitled to a deduction under s. 20(1)(f)(ii) on the partial redemption of a Note that was exchangeable into "Underlying Shares," CRA stated:

Prior to Imperial Oil Ltd. v. Canada, the CRA's position with respect to the exchangeable debentures with or without an original discount was that a deduction was generally available under paragraph 20(1)(f) with respect to the original discount as well as the appreciation of the principal amount of the debenture over its face value, provided that such appreciation was inherent to the terms and conditions of the debenture.

In light of the decision of the Federal Court of Appeal in the Tembec case, we are now of the view that our above-mentioned position is not supportable at law. Hence, this case limits the deduction of financing costs provided for by paragraph 20(1)(f) to the original discount, granted when an obligation is issued. The appreciation of the principal amount of the debenture over its face value is not deductible under paragraph 20(1)(f). This represents a change of position and will therefore be administered on a prospective basis to debentures issued on or after January 1, 2010. In this respect, a debenture issued prior to January 1, 2010 but modified on or after that date will be considered issued on or after January 1, 2010.

A predecessor of the taxpayer had issued an exchangeable debenture exchangeable into share of a corporation (“Corporation 2”) of which the taxpayer was one of the shareholders. Subsequently, the taxpayer sold the shares at a capital gain and repaid the exchangeable debenture including a cash premium (the “Premium Paid”) reflecting the appreciation in the underlying shares. Another predecessor of the taxpayer monetized its shares of Corporation 2 by entering into a forward sale with a third party (the “Purchaser”) and pledging that forward sale agreement and its shares to a Bank as security for a loan. This forward transaction was subsequently closed out by the taxpayer in connection with its sale of the Corporation 2 shares and use of the proceeds to repay the loan and pay a cash Maturity Payment to the Purchaser based in part on the appreciation in the shares’ value.

In its financial statements, the taxpayer included the amounts of the Premium Paid and the Maturity Payment in the amount of its interest expense, which it deducted. On audit, its representative instead submitted that the two payments were deducted pursuant to s. 20(1)(f)(i).

The Directorate found that the application of s. 20(1)(f) to the Premium Paid was to be determined in accordance with CRA’s policy applicable to debentures issued before 2010. However, under that policy, only half of the Premium Paid was deductible (under s. 20(1)(f)(ii) rather than (i)) in light of the size of the discount between the value of the underlying shares on the maturity date (viewed under that previous policy as being the principal amount) and the face amount of the debentures.

Respecting the Maturity Payment, it did not satisfy the s. 20(1)(f) wording, as a “forward transaction cannot be considered to be any bond, debenture, bill, note, mortgage, hypothecary claim or similar obligation” (Federated Co-op was cited in this regard). Accordingly, the Maturity Payment was a payment on capital account whose deduction claimed under s. 20(1)(f)(i) should be denied.

A foreign exchange loss realized on the settlement of a foreign currency debt of the taxpayer would be recognized under s. 39(2) rather than under s. 20(1)(f). "For purposes of paragraph 20(1)(f) of the Act, we believe that the time at which the 'principal amount' is to be determined should be at the time of issue and this is the relevant time at which the discount, if any, should also be ascertained." Documents relating to exchangeable debentures can be distinguished on the basis that there was no issue in those cases that paragraph 20(1)(f) was the relevant provision of the Act.

Where existing mortgage loans made to farmers had their terms changed so that the principal was linked to a commodity price, a payment in excess of the amount for which the obligation was issued would be deductible at maturity under s. 20(1)(f).

An amount, which is included in the income of an individual (X) under s. 15(2) is also subject in the individual’s hands to the tax on split income (TOSI) under s. 120.4(2) (TOSI), so that X is entitled to a deduction under s. 20(1)(ww) for the income subject to TOSI (being also equal to the s. 15(2) income inclusion).

In a subsequent taxation year, X repays the shareholder loan. Does having claimed the s. 20(1)(ww) deduction preclude X from subsequently claiming the s. 20(1)(j) deduction when the loan is repaid? S. 20(1)(j) refers inter alia to “such part of any loan or indebtedness repaid by the taxpayer in the year as was by virtue of subsection 15(2) included in computing the taxpayer’s income for a preceding taxation year (except to the extent that the amount of the loan or indebtedness was deductible from the taxpayer’s income for the purpose of computing the taxpayer’s taxable income for that preceding taxation year) … .”

CRA noted in response that s. 20(1)(ww) provides a deduction in computing income, whereas the bracketed phrase contained in 20(1)(j) only applies to the deductions in computing taxable income. Consequently, X having claimed the s. 20(1)(ww) deduction should not preclude X from subsequently claiming the s. 20(1)(j) deduction when the loan is repaid – and that this appears to be the right policy result.

A shareholder loan repaid by the executors of the shareholder within one year after the end of the creditor's taxation year in which the loan was made will be treated in the same manner as a repayment by a surviving shareholder.

CRA stated that where the loan is not repaid by the estate within one year:

[T]he Estate can claim the deduction under paragraph 20(1)(j) in the year a repayment is made to the extent that the deceased person had included the amount of the loan in computing his or her income pursuant to subsection 15(2) in a preceding taxation year….[H]owever…CRA has indicated in technical interpretation 9918015 that [this] position in paragraph 32 of IT-119R4 does not apply where the loan is subsequently repaid by a beneficiary of the Estate.

RC will not follow the accounting standard for "Impaired Loans" that was recently approved by the CICA, nor the guidelines for federally regulated financial institutions issued by OSFI with respect thereto.

Discussion of the reserve by an account holder or investment certificate holder of a financial institution in bankruptcy.

The principal factors to be considered respecting the presence of a money-lending business are whether loans have been made or debts created, the presence of a debtor/creditor relationship and an intention of the taxpayer to earn interest income. Accordingly, a leasing business may not be a money-lending business.