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: General Information re: Security Lending Arrangements
Position: General Information Provided
Reasons: N/A
May 2, 2000
WINNIPEG TAXATION CENTRE HEADQUARTERS J. P. Dunn Attention: Cyndi Martin - Conway (613) 957-2747 Enquiries 1999-001435
Security Lending Arrangements - Dividend Compensation Payments
We are writing in response to your correspondence of December 10, 1999 in which you had requested information regarding the treatment for income tax purposes of certain transactions related to the "short selling" of securities. We apologize for the delay in responding to your enquiry.
The provisions of section 260 of the Income Tax Act govern the treatment of such transactions which are referred to therein as "security lending arrangements". Generally, a security lending arrangement is a transaction in which the seller of a security does not own the security to be sold and, in order to effect the sale, borrows the security from the actual owner (the "security lender"). The short seller (the "security borrower") then sells that borrowed security to a third party.
Because any dividends (or interest in the case of a bond or debenture) which are paid by the issuer of the security will be received by the new third party owner of the security, the original owner (the "lender") will expect to be compensated for those dividends by the borrower of the security. The treatment for tax purposes of the receipt of such compensation payments by the security lender is governed by subsection 260(5) of the Act while the treatment for the payor of the amount (the "security borrower" is governed by subsections 260(6) and (6.1) of he Act. With respect to the recipient (the "security lender"), an amount received as compensation for a dividend on the security will be deemed to have been received by that person as a taxable dividend on the share to the extent that the various conditions prescribed in subsection 260(5) are met. With respect to the payor of the compensation payment, subsection 260(6) of the Act provides that no amount of that payment is deductible unless the payor is a "registered securities dealer", as that term is defined in subsection 248(1) of the Act, in which case the deduction allowed is two-thirds of the amount. As you had noted, however, clause 82(1)(a)(ii)(B) of the Act allows an individual to reduce the actual amount of dividends received in the year from corporations resident in Canada by the amount paid as dividend compensation payments to the extent that such amount is deemed by subsection 260(5) to have been received by the recipient as a taxable dividend. Again, as noted by you, this deduction is limited to the actual amount of such dividends received in the year so that, if the security borrower has not received any dividends in the year from corporations resident in Canada, no deduction will be available with respect to a dividend compensation payment (unless, as noted previously, the payor is a "registered securities dealer"). Subsection 260(6.1) of the Act provides a similar result to a corporate borrower of securities under a "dividend rental arrangement", as that term is defined in subsection 248(1) of the Act, for compensation payments made with respect to borrowed shares upon which the corporate borrower has been denied a deduction for those dividends pursuant to subsection 112(2.3) of the Act. In a dividend rental arrangement, the borrower of the shares keeps the shares in order to receive the dividend while, under a short sale, the borrower of the shares would sell the borrowed shares to a third party who will receive the actual dividends paid by the share issuer. Because both situations involve the borrowing of securities, both come within the provisions of section 260 of the Act dealing with "security lending arrangements".
With respect to any gain or loss arising on the "short sale" transaction itself (as opposed to any dividend compensation payments), it is our view that, generally, such gains or losses are on account of income, however, the determination in any specific instance would depend on a review of the facts and circumstances particular to that situation.
We trust that this is the information which you require.
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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