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.
Principal Issues: Is EBITDA calculation a "participating debt interest"
Position: No
Reasons: Measures creditworthiness of borrower
2008-030139
XXXXXXXXXX C. Tremblay, CMA
(819) 281-6906
May 29, 2009
Dear XXXXXXXXXX :
Re: Participating Debt Interest
This is in reply to your letter of November 6, 2008, wherein you ask whether in the situation you describe the interest would be considered "participating debt interest" as defined in subsection 212(3) of the Income Tax Act (the "Act").
In your situation, an interest-bearing loan is made to a Canadian taxpayer by a person with whom the taxpayer is dealing at arm's length and all or a portion of the interest rate is based on the ratio of certain debt to earnings before interest, taxes, depreciation, and amortization ("EBITDA") of the borrower such that the interest rate is reduced as debt decreases in relation to EBITDA. This adjustment to the interest rate is intended as a reflection of the creditworthiness of the borrower such that the interest rate is reduced as the credit risk to the lender decreases. In your example, the interest rate may be reduced from an agreed "cap" interest rate based on the ratio of certain debt to EBITDA of the borrower.
Our Comments:
Your question appears to involve actual taxpayers and a factual situation. As such, we are unable to definitively reply to your question until we have had the opportunity to review all the facts and related documentation. Such a review is conducted by the relevant tax services office where the query relates to a completed transaction, or by this directorate where the arrangement is the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5. We nevertheless offer the following general comments regarding the relevant provisions of the Act that may apply. Since these comments are general in nature, they may or may not apply in your situation and are not binding on the Canada Revenue Agency.
In subsection 212(3) of the Act, the definition of "participating debt interest" means "interest (other than interest described in any of paragraphs (b) to (d) of the definition "fully exempt interest") that is paid or payable on an obligation, other than a prescribed obligation, all or any portion of which interest is contingent or dependent on the use of or production from property in Canada or is computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion or by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation."
"Participating debt interest" as defined in subsection 212(3) of the Act is, very generally speaking, interest that depends on the success of the payer's business or investments. In its details, the definition draws directly from the prior concluding portion (the postamble) of former paragraph 212(1)(b) of the Act, and it is intended to have the same effect.
In a prior ruling (2005-01615221R3) on former subparagraph 212(1)(b)(vii) of the Act, the interest payable was referenced to, inter alia, an applicable margin based on the borrower's total leverage ratio. We ruled favourably because the extra amounts payable simply used EBITDA as a tool to assess creditworthiness. As the borrower became more profitable, its payments decreased, and, in our view, this reflected the opposite of participating debt. Today, we are of the same view, and, generally, where the interest rate is capped and any reduction thereto would be intended as a reflection of the creditworthiness of the borrower, the interest would not constitute "participating debt interest" within the meaning of that term as defined in subsection 212(3) of the Act.
We trust that our comments will be of assistance.
Yours truly,
R. Albert, CA
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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