2018 Ruling 2018-0740931R3 F - deductibility of interest – convertible debentures -- summary under Subparagraph 20(1)(c)(i)

Proposed transactions

1. ACo, a listed Canadian public company, whose outstanding convertible debentures (the “Debentures”) are about to mature, will borrow from a lender (BCo) under “Loan 3.”
2. It then will issue a redemption notice to redeem all of the outstanding Debentures for their principal amount plus accrued interest.
3. Since the Debentures have a substantial accrued gain based on their conversion price and the market price of ACo’s shares, this will prompt most or all of the holders of the Debentures to exercise their conversion rights.
4. However, upon receiving the notices of redemption for the Debentures, ACo will have the right to redeem such Debentures for an amount corresponding to the market value of the ACo shares into which they are convertible – which it will do, using proceeds of Loan 3 and thereby paying a “Conversion Premium C” over the redeemed Debentures’ principal amount.
5. The Conversion Premium will be less than ACo’s accumulated profits.

Rulings

CRA ruled (TaxInterpretations translation):

To the extent that the portion of Loan 3 (as described in paragraph 25 above of the Proposed Transactions of the Letter [see 1 above]) will be used by ACo in order to pay the Conversion Premium C (as described in paragraph 26 of the Proposed Transactions of the Letter [see 4 above]) in replacement of the capital of ACo (being its “accumulated profits” (as described in paragraphs 1.50 and 1.51 of Income Tax Folio S3-F6-C1, Interest Deductibility) for purposes of the “filing-the-hole” concept used in applying paragraph 20(1)(c)) not exceeding the amount of the Conversion Premium C which is used by ACo for an eligible purpose, and that such capital will continue to be used for eligible purposes for purposes of the application of subparagraph 20(1)(c)(i), the interest paid in the year or payable in the year (depending upon the method regularly followed by the taxpayer in computing its income) by ACo, pursuant to a legal obligation to pay interest on borrowed money (being the portion of Loan 3 which will be used by ACo to pay the Conversion Premium C), will be deductible by ACo in computing its income for the year pursuant to subparagraph 20(1)(c)(i). However, such interest will be deductible only to the extent that it is reasonable in the circumstances and provided that the deduction is not prohibited by virtue of another specific provision of the Act.

Completed transactions

Similar Debenture redemption transactions had already been completed (involving the application of “Loan 1” and “Loan 2”), and CRA provided similar rulings for these.