(2)-(14)

A financial institution (the "Issuer") will accumulate a pool of mortgages [presumably CMHC-guaranteed in most cases] and sell an undivided interest in the mortgages to investors (the "Investors"). The mortgages will be sold, on a fully-serviced basis, by the Issuer for a single aggregate consideration, with respective undivided beneficial ownership interests in such pool represented by written instruments.

The ruling summary states that:

The interest paid is considered to be 'fully exempt interest' as defined in subsection 212(3) of the Act for the purposes of subparagraph 212(1)(b)(i) of the Act.

CDS trust entered into credit default swaps with a counterparty (a non-resident Bank) desiring credit protection for its bond portfolios and funded its purchase of the required collateral for its CDS obligations by issuing short-term notes. It defaulted on the notes in the 2008 financial crisis.

It settled litigation with the bank under a compromise which was voted on and approved by the Noteholders under a CCAA plan. Under this settlement, the Bank (which in the meantime had acquired some of the Notes directly and through non-resident subsidiaries) made payments under the CDS, which were applied by the Trust to repay all of the unpaid Note principal but only a portion of the unpaid interest (with recourse for such interest obligations being specified in the CCAA plan to be only to the Trust assets.)

CRA ruled that the payments of interest by the Trust to the Bank (and non-resident subsidiaries of the Bank) will not be "participating debt interest," stating:

The fact that interest would be paid by the Trust based on the available cash in the Trust…(i.e., the fact that the Trust will not be able to pay all the interest it owes…) does not impact the conclusion that the interest on the Notes is not being computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion.

See more detailed summary under s. 212(1)(b).

Aco, a public corporation, will issue (at no discount or only a shallow discount) the "Notes" which: will rank equally with its other unsecured debt; will bear interest at specified fixed or floating rates, will not (in the case of the fixed rate Notes) be redeemable before the first interest reset date (except on the occurrence of specified events) and will be automatically converted into common shares based on a predetermined conversion formula (presumably at the point of non-viability as defined by OSFI, subject to regulatory discretion), so that there is no assurance that the conversion formula would result in the issuance of common shares having a fair market value at least equal to the principal.

Rulings

: Interest is not participating debt interest; s. 20(1)(c) deductibility of interest (subject to standard conditions);.

• mature XX years from the issue date
• bear fixed interest payable semi-annually, at the option of Aco, in cash or in class A shares ("common shares") calculated by dividing each interest amount by the current market price on the date falling XX days prior to the interest payment date
• convertible into common shares at the option of the holder until shortly before maturity at a fixed conversion price (subject to anti-dilution protection)
• on conversion holders will receive accrued but unpaid interest and a "Make-Whole Amount" (payable in common shares or in cash where the Exchange limits payment in shares) in respect of lost future interest, but with a reduction of XX% for each XX% that the current market price at the time of conversion exceeds the conversion price
• Aco has the right to require conversion following the X anniversary

Concurrently with the above public offering Aco makes placement of subscription rights by private placement to "USco" comprising "Private Debentures" and warrants with "substantially similar" terms (but with expanded ability to pay the make-whole in cash). The Private Debentures and warrants may not be converted or exercised if that would result in USco holding more than XX% of the common shares.

Rulings

The payments made by Aco to the Debenture holders are not "participating debt interest." S. 212(1)(b) of the Act will not apply to the conversion of any of the Public Debentures or Private Debentures held by a non-resident of Canada or by virtue of any interest payment or any Make-Whole Amount under the Public Debentures or the Private Debentures, provided that the holder of the debenture deals at arm's length with Aco.

[R]egular periodic interest payments made by public corporations pursuant to the terms and conditions of standard convertible debentures do not generally constitute "participating debt interest"… .

[T]he deemed payment of interest on standard convertible debentures under subsection 214(7) of the ITA that arises because of a transfer or assignment of standard convertible debentures by a non-resident person to a person resident in Canada (including the issuer of the debenture), does not generally constitute "participating debt interest". …

CRA is not inclined at this time to take the position that standard convertible debentures would in general constitute "excluded debt obligations" pursuant to paragraph 214(8)(c) of the ITA.

"CRA cannot provide certainty concerning the application of Part XIII tax to the very broad range of situations in which convertible debentures can be issued" and taxpayers are encourage to seek advanced income tax rulings to resolve any concerns.

The Corporation, a "mortgage investment corporation" under s. 130.1(6), pays dividends which take into account, inter alia, its income and financial conditions. Such dividends are deemed by ss. 130.1(2) and 214(3)(e) to be paid to the shareholders "as interest on a bond." In refusing to rule that the interest was not participating debt interest, CRA stated:

[T]he dividends paid from the Corporation, which are deemed to be interest, were computed by reference to the income, profit, cash flow or other similar criterion described in the definition of PDI. Accordingly, the deemed interest payments would meet the condition that they are interest paid on an obligation and that they are of a participatory nature described in the definition of PDI.

amendments made by 2014-0532411R3 shown in red italics

PUBCO, which is a listed public corporation and a taxable Canadian corporation, completed an offering of Convertible Notes, including Convertible Notes ("Class XX Notes") purchased on behalf of ACO, which is a non-resident corporation which deals at arm's length with PUBCO.

The Class XX Notes:

• were not issued at a discount and pay no premium
• are payable in US dollars
• have a specified maturity date for payment of the aggregate principal together with accrued interest
• bear interest of XX% payable semi-annually, subject to a gross-up clause
• are convertible into common shares (having a stated capital equal to the converted principal) at the option of the holder at the conversion price at any time prior to the earlier of the maturity date and the business day preceding the date which PUBCO has specified for their redemption (see below)
• a cash payment is made in lieu of the issuance of a fractional share on conversion
• accord PUBCO, in the case of a conversion request received from the BCO group, to elect to satisfy its obligations by delivering common shares in its capital stock at the Conversion Price or the cash equivalent thereof (based on their then market price)
• are redeemable by PUBCO for their principal and accrued interest at any time before maturity provided that the current market price of the PUBCO common shares is at least x% of the conversion price
• do not give PUBCO the right to pay the redemption price with common shares

Rulings

that the regular semi-annual interest payments will not be "participating debt interest" and that their payment to ACO will not be subject to Part XIII tax provided PUBCO deals at arm's length with ACO at the time of the payments. Supplementary ruling that "any amount deemed to be a payment of interest on a Class XX... Note under subsection 214(7) as a result of a conversion of the ... Note into Common Shares ... will not be subject to Part XIII withholding tax under paragraph 212(1)(b)" on the same arm's length assumption.

Opinion.

[On] a disposition of a Class XX... Note by ACO to a person resident in Canada (other than PUBCO) for proceeds of disposition payable in cash, any amount deemed to be a payment of interest on a Class XX...Note under subsection 214(7) would not in general constitute "participating debt interest"... .

Traditional convertible debentures are: unsecured subordinated obligations of a public corporation issued in Canadian dollars for their face value; bear interest (payable at least annually) at a fixed rate; provide a fixed conversion price (or ratio) in excess of the current market price on the issue date; and are redeemable by the issuer at the face value, plus accrued and unpaid interest, on the specified maturity date. CRA stated:

Where there is a conversion of a traditional convertible debenture by its original holder for common shares of the issuer, … in general there would be no Excess under subsection 214(7)… . Accordingly, no amount is deemed to be a payment of interest by the issuer (person resident in Canada) to the non-resident person for the purposes of Part XIII. For the purpose of paragraph 214(7)(d) of the ITA, the price for which the traditional convertible debenture is assigned on the conversion, is the amount determined by multiplying the fixed conversion price by the number of shares received on the conversion, that is, an amount corresponding to the face value of the traditional convertible debenture.

Where (in order to reflect the resulting increased credit worthiness of the borrower) the interest on a loan decreases as the ratio of debt to EBITDA of the Canadian borrower decreases, such interest will not be considered to be participating debt interest.

Where holders of notes receive at maturity a return linked to the performance of three mutual funds, the post-amble under s. 212(1)(b) will not apply so as to deny the availability of exemption in s. 212(1)(b)(vii). The issuer was not related to the mutual funds nor were the profits of the mutual funds linked to the issuer.

An interest rate under a term facility intended to qualify for the exemption under s. 212(1)(b)(vii) was equal to LIBOR plus a spread which decreased as the leverage (measured by the ratio of funded debt of the borrowers to EBITDA) decreased. CRA ruled this arrangement did not cause the post-amble to s. 212(1)(b) to apply. Although the interest payable varied as a result of changes in EBITDA, the extra amounts payable simply used EBITDA as a tool to assess creditworthiness and, as the borrower became more profitable, payments decreased, which was the opposite of participating debt.

"A loan agreement that contains a provision for increased payments to the lender that are based on the ratio of certain debt to EBITDA ... of the borrower may fall within the ambit of the broad wording in the postamble ... ."

CCRA "would not generally consider interest that is computed by reference to a stock index as satisfying the exception conditions described in the postamble to paragraph 212(1)(b) ... as long as the Agency is satisfied that the particular index chosen is not influenced by the inclusion in that index of the shares of the issuing corporation, corporations related to the issuing corporation or a corporation or corporations whose primary business is substantially similar to that of the issuing corporation ... [O]ur response is predicated on the understanding that the return on the obligation does, in fact, represent 'interest' on the obligation."

The Agency would not generally consider the return computed by reference to a foreign stock index to be "computed by reference to revenue, profit, cash flow, commodity price or any other similar criterion" as long as the Agency is satisfied that the particular index chosen is not influenced by the inclusion in that index of the shares of the issuing corporation, corporations related to the issuing corporation or a corporation or corporations whose primary business is substantially similar to that of the issuing corporation. "Also, the Agency would want to be satisfied that the debt obligation is not used by a non-resident of Canada as a substitute for direct investment in the underlying securities in an index where dividends or gains on those securities will be subject to tax in Canada if held directly by that non-resident."

Before concluding that it generally would be acceptable for the interest rate on a debt instrument to vary in accordance with the value of a foreign currency, the Directorate stated "although foreign currency can be bought and sold and as such could be considered a commodity, it is our position that in the context of the paragraph 212(1)(b) postamble, 'commodity price' should not be considered to include foreign currency fluctuations, but rather in general is to be limited to, for example, prices for tangible commodities ...&nbsp."

To date the Directorate has not adopted a position that would extend the position in ITT in No. 11 to debt linked to a stock index such as the Dow Jones Industrial Average.

A US LLC ("Corporation C"), whose sole member was a US corporation qualifying for benefits under the Canada-US Convention, ran a platform for the provision of "Digital Content" (movies, television shows, music videos, documentaries and similar audio-visual content) which it (and affiliated corporations) were permitted to distribute under content licence agreements with the third-party holders of the copyright. Canadian distributors (described as "Customers") created online storefronts for Canadian individual home users, running on Corporation C's platform, with customized design and branding for the Canadian Customers. Although the home users were licensed the right to receive Digital Content by virtue of agreements they entered into only with the Canadian Customers, it was Corporation C which collected the fees from them and operated the "online store," and it was stated in the description of facts to be the beneficial owner of those payments.

CRA ruled that monthly fees paid by the Customers to Corporation C for managing and maintaining components of the Customers' storefronts, for continuing access to the sales platform, and related support services, were (to the extent they otherwise could be considered to be management or administration fees or charges) not subject to Part XIII tax under s. 212(1)(a) by virtue of s. 212(4)(a) (as well as ruling that fees collected from Canadian home users were exempt from Part XIII tax under Art. XII(3)(a) of the Convention).

Annual payments made by a non-resident person carrying on business in Canada to a non-resident software supplier for updates, maintenance and servicing of computer software would not qualify as payments of "rent" and, accordingly, would not come within s. 212(13)(a). A review of judicial decisions indicated "that rent is generally a fixed payment (usually periodic) for the use of property for a given period of time, after which the right to use the property would extinguish (i.e., the right would be reverted back to the owner ... [O]nly in rare and unique situations would the word 'rent' be considered to mean 'royalty'".

If a partnership between a Canadian corporation and a non-resident corporation carrying on business in Canada is not entitled to deduct royalties in computing its income from a source in Canada, tax need not be withheld on the royalty payments.

For purposes of determining whether income is earned on a reserve, income from sources other than those enumerated in IT-62 generally will be considered to have their source at the payor's principal place of business, e.g., the head office of a payor bank.

Where a Canadian-resident tenant pays rent

to a partnership that has one or more partners who are not resident in Canada…the [Part XIII] withholding applies to the full amount of the payment even though some members of the partnership are residents of Canada.

Where s. 212(13.1)(b) applies to payments to a partnership of which there is a non-resident limited partner, Part XIII tax will be applicable to the entire amount of such payment rather than the portion of such payments allocated to the non-resident partner.