A Canadian public company (ACo ) will force the conversion of its outstanding convertible debentures, by issuing a notice to redeem them for their principal amount. However, upon receiving notice that the debentureholders are converting, it will then exercise a further right to redeem such debentures in cash for their value based on the market value of the underlying shares, thereby resulting in the payment by it of a substantial cash redemption premium. The redemption will be funded with borrowed money.
CRA applied the “fill the hole” concept to rule that the interest on the borrowed money used to pay the premium will be deductible under s. 20(1)(c)(i) given that the accumulated profits of ACo at the time of the redemption will exceed the premium. It also ruled:
Subsection 20(3) will be applicable to the portion of Loan 3 … corresponding to the aggregate principal amount of the outstanding Debentures … such that borrowed money will be deemed for purposes of the application of paragraph 20(1)(c) to be used for the purposes for which the outstanding Debentures were used or incurred.
Similar debenture redemption transactions had already been completed, and CRA provided similar rulings for these.