31 July 1990 Income Tax Severed Letter ACC9365 - Securities Lending Arrangements

24(1)

                                  5-900428
                                  C. Robb
                                  (613) 957-2744

Attention: 19(1)

July 31, 1990

Dear Sirs:

Re: Securities Lending Arrangements

We are writing in response to your letter of April 11, 1990 in which you requested our views concerning the application of the definition of securities lending arrangement ("SLA") which is included in proposed subsection 260(1) of the Income Tax Act (the "Act"). The example in your letter involves the loan of securities to a stockbroker and the writing by the lender of a call option, in respect of the loaned securities, with the stockbroker or with a third party in an arm's length transaction.

The facts in your letter appear to relate to actual proposed transactions. Therefore no specific confirmation can be provided in this response. Revenue Canada, Taxation ("RCT") provides advance income tax rulings on the income tax consequences of proposed transactions where the issues involved are primarily questions of interpretation of the Act. The issues raised in your letter include questions of specific opinion or an advance income tax ruling. Nevertheless, we have set out below our general comments on the interpretation issues raised in your letter.

Whether or not the writing of a call option referable to a loaned security is part of an arrangement which includes a securities loan is a question of fact to be determined by reference to all of the circumstances of a particular case.

In our view, it is unlikely that the conditions of paragraphs 260(1)(b) and (d) could be satisfied where the call option is written with the stockbroker to whom the security is loaned. Depending on the particular circumstances, it may be unreasonable to expect at the time the security is loaned that an identical security will be returned by the borrower to the lender as is required by paragraph 260(1)(b). For example, on exercising the call option the stockbroker could offset his obligation to return a loaned security with the call option writer's obligation to deliver the borrowed security. It is our view that the writing of a call option referable to a loaned security would, in general, materially change the call option writer's opportunity for gain or profit with respect to the loaned security. The maximum proceeds the lender could be expected to receive for the loaned security is limited to the exercise price of the option. Therefore, the condition in paragraph 260(1)(d) would not be satisfied.

Where the lender of the security writes a call option on a loaned security with a third party (i.e., a party other than the borrower), the conditions in paragraph 260(1)(b) may be satisfied. However, it is possible that in some circumstances it would be reasonable to conclude that the writing of the call option would be part of an arrangement that includes the lending of securities with the stockbroker. In such a case, the condition in paragraph 260(1)(d) would not be satisfied and the arrangement would consequently not be a SLA within the meaning of subsection 260(1).

The opinions provided in this letter are general in nature and relate to proposed legislation, the final form of which may differ from that contained in Bill C-28 passed by the House of Commons on December 20, 1989. Our opinions are provided in accordance with the practice described in paragraph 24 of Information Circular 70-6R.

Yours truly, for Director Financial Industries Division Rulings Directorate