23 March 1990 Ministerial Correspondence 90M03244 F - Tax Executive Institute's Questions

SUBJECT:  Tax Executives Institute's Questions

Attached are copies of our formal responses to the questions discussed at the January 11, 1990 meeting with the Tax Executives Institute.

Brian DarlingDirector Financial Industries DivisionRulings Directorate

Question 1 - REVENUE CANADA TAXATION (RCT) TREATMENT OF ZERO COUPON BONDS

Since it is the discount on the issue of the zero coupon bond that is being amortized, the first concern is whether or not this amount is interest.

If this amount is interest, then in our opinion, the only acceptable method of amortizing the interest payable is what is commonly referred to as the simple-compound method, i.e. simple interest when payable and compound interest when paid.

Our understanding of the "actuarial" method of amortization is that it is based on the assumption that the simple interest payable at the end of each year is capitalized and subject to a simple interest rate in future years.  Since compound interest is built into this method and would result in a deduction for compound interest on a payable (rather than paid) basis, this would be contrary to the specific legislative requirements of paragraph 20(1)(d).

The Department of Finance is aware of the possible lack of symmetry between the tax treatment of the holder and the issuer of zero coupon bonds and will presumably take it into account in their current review of the interest expense issues.

Question 2 - LOW INTEREST LOANS

Department's Position

IT-239R2 does not discuss the utilization of losses as an acceptable transaction but rather says that any loss on the loan to the subsidiary suffered by the parent corporation in the above circumstances may be a deductible capital loss, despite the absence of a reasonable rate of interest on the loan to the subsidiary. Paragraph 7 of IT-445 deals with the circumstances in which a deduction for the full interest expense incurred on money borrowed by a parent corporation and reloaned to its Canadian subsidiary is accepted by RCT, notwithstanding that the conditions in paragraph 20(l)(c) have not been met.  This position is included in the Notice of Ways and Means Motion tabled in the House of Commons on November 24, 1989.  The administrative treatment extended by the motion does not include non-interest bearing or low interest rate loans from a subsidiary to its parent as part of an arrangement to utilize the parent's losses.  Therefore, the interest expense incurred by the subsidiary on money borrowed and reloaned to its parent would not be deductible.

RCT has noted that in-house share investments are sometimes used as part of a series bf transactions designed to effect loss utilization in a corporate group.  Where there was commercial reality to these transactions, RCT has ruled that the general anti-avoidance rule would not apply.

Question 7 - TERM PREFERRED SHARES

Department's position

(a)     "Sufficient common connections or business interests" is one of the factors to be considered.  There could be others.

(b)     If the 5% exchange premium is given to reflect the saving of brokerage fees and other similar costs of issue, then such a premium in and  by itself would not cause the preferred share to be a term preferred share.

Question 9 - LEASING PROPERTY RULES

Department's Position

(a)     RCT intends to accept a grouping in the circumstances referred to in the explanatory notes to the draft regulations, i.e. where the properties are all of the same class and subject to the same lease.  Taxpayers must, however, retain the records necessary to support their tax calculations or to support adjustment where some of the properties are disposed of.

(b)     The separate class election provided for in subsection 1101(5o) of the draft regulations is to be made by way of a letter attached to the T2 return for the taxation year in which the properties were acquired.  The information contained in the letter should be sufficient to identify the property.