4 March 1999 External T.I. 9824125 - INTEREST - CONVERTIBLE DEBENETURES

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether convertible debentures are exempt from 212(1)(b) withholding tax?

Position: No

Reasons: They are not convertible into a prescribed security.

XXXXXXXXXX 									982412
B. Kerr
Attention: XXXXXXXXXX 

March 4, 1999

Dear Sirs:

Re: Subparagraph 212(1)(b)(vii) of the Income Tax Act, (the “Act”)

This is in response to your letter of September 16, 1998, requesting a technical interpretation concerning the application of subparagraph 212(1)(b)(vii) of the Act to debt obligations.

You have described the debt obligations as 10-year debentures where the issuer may on thirty days notice redeem the debentures. They may also be convertible or exchangeable into deposit notes of the issuer if the issuer obtains the approval of the Superintendent of Financial Institutions.

In support of your view that the exemption from withholding tax on interest in paragraph 212(1)(b)(vii) should apply, you have referred to Interpretation Bulletin IT-361R3 wherein paragraph 7 states that “Generally, an obligation which otherwise qualifies under subparagraph 212(1)(b)(vii) is not disqualified only because repayment is permitted, at the issuer’s discretion, of more than 25 percent of the principal amount within 5 years of the date of issue; that is there is no obligation on the part of the issuer to make the payment.”

Our Comments

The situation outlined in your letter involves an actual fact situation. To the extent that it relates to a past transaction you should contact the appropriate Tax Services Office, since the review of such transactions falls within their responsibility and it is the practice of the Department not to comment on such transactions when the identities of the taxpayers involved are not known. If it relates to a proposed transaction, assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular IC 70-6R3 dated December 30, 1996, issued by Revenue Canada. However, we can offer he following general comments

Subparagraph 212(1)(b)(vii) of the Act provides that Part XIII tax is not payable by a non-resident person on interest received from a corporation resident in Canada if, inter alia, under the terms of the obligation or any agreement relating thereto the corporation may not, under any circumstances, be obliged to pay more than 25% of the principal amount thereof within five years of the date of its issue except in the event of, inter alia, the non-resident person exercising a right under the terms of the agreement relating thereto to convert the obligation into, or exchange the obligation for, a security prescribed for this purpose by subsection 6208(1) of the Income Tax Regulations.

As you are aware, we have previously concluded that the phrase “under any circumstances” is worded broadly enough to include the situation of a possible payment by the issuer even where the issuer must independently take steps to create a right of conversion for the holder of an obligation. As stated in paragraph 2 of IT-361R2, an obligation will fail to qualify for the exemption under subparagraph 212(1)(b)(vii) if it is convertible (whether into another obligation or in any other manner other than into a prescribed security as noted above) within five years of its issue. As requested, we have reviewed our position and considered the arguments set out in your letter, however, it is still our view that the proposed addition of the conversion right, even if done solely at the issuer’s discretion, constitutes a circumstance under which the issuer of the obligation may be obliged to pay more than 25% of the principal amount of the obligation within 5 years. Since the debt obligation you describe is not convertible into a prescribed obligation as permitted by clause 212(1)(b)(vii)(E) of the Act, the Department’s position as described in paragraph 2 of IT-361R3 would apply. The exception you refer to as outlined in paragraph 7 of IT-361R2 would not apply since the obligation does not “otherwise qualify” because of the conversion feature.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch