Principal Issues: In a securities lending arrangement, is a compensation for dividends paid to the lender represent a lease obligation for the purposes of paragraph 95(2)(a.3) of the Act?
Position: It can be argued that the obligations under a securities lending arrangement described in section 260 of the Act falls within the scope of a lease obligation because the expression "lease obligation" is worded broadly to include an obligation under an agreement that authorizes the use of property.
Reasons: The borrower has an obligation to pay the two kinds of compensation. Nothing in the definition of lease obligation limits an obligation to use the property to an obligation that constitutes an incremental benefit to the lender.
XXXXXXXXXX 2006-020536
May 14, 2007
Dear Sir:
Re: Lease Obligations
This is in reply to your letter of September 11, 2006 in which you requested our opinion on the application of paragraph 95(2)(a.3) of the Income Tax Act (the "Act"). The situation presented involves a loan of securities by a controlled foreign affiliate of a Canadian corporation. The controlled foreign affiliate carries on the business of a trader or dealer in equity securities in its country of residence.
As mentioned in your letter, a securities lending arrangement ("SLA") may comprise two types of payment:
-a fee paid by the borrower to the lender as consideration for the use of the security;
-a dividend compensation payment to remit to the lender all amounts paid as dividends or interest on the underlying security.
In the absence of specific provisions of the Act providing otherwise, it can be argued that a payment made under an SLA, as contemplated in subsection 260(1) of the Act, falls within the scope of a lease obligation. This is because the expression "lease obligation" of a person, as defined in subsection 95(1) of the Act, is worded broadly to include an obligation under an agreement that authorizes the use of property. The result of this interpretation may be to treat a dividend compensation payment as Foreign Accrual Property Income, as defined in subsection 95(1) of the Act. As this result may not accord with tax policy in the circumstances of your letter, we are sending a copy of our reply to the Department of Finance to point out a possible unintended broad application of lease obligation. The CRA deals with requests on a case-by-case basis. In the circumstance you describe, we cannot provide, without examining the relevant documentation, any assurance that the dividend compensation payment would not be regarded as being within the scope of the expression "lease obligation". You may wish to consider submitting a request for an advance income tax ruling in this regard.
We trust the above comments will be of some assistance.
Yours truly,
Alain Godin, Manager
for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Cc Department of Finance