2016-0666411E5 Negative returns on investments

Principal Issues: 1. In the scenarios described, how is a negative return on overnight cash deposits characterized? 2. How are losses on a negative yield bond reported?

Position: 1. Based on the information submitted for the hypothetical scenarios, the negative returns on the Deposits would be deductible in computing income under subsection 9(1). 2. If the bond is held on account of capital, the capital loss may be deemed to be nil pursuant to subparagraph 40(2)(g)(ii). If the bond is held on account of income and the limitation under paragraph 18(1)(a) does not apply, the loss is on account of income.

Reasons: 1. The negative return does not constitute interest as it is not compensation for the use of funds. However, in the scenario described, it is reasonable to consider that the negative return was incurred for the purposes of earning income. 2. See discussion.

Author: Ferrari, Rob
Section: 9(1), 18(1)(a), (b)

XXXXXXXXXX                                                                                                             2016-066641
                                                                                                                                     R. Ferrari
June 14, 2017

Dear XXXXXXXXXX:

Re: Negative returns

This is in reply to your email of July 12, 2016.  We also acknowledge the additional information provided by email and telephone.  You have presented hypothetical scenarios in which negative returns (sometimes referred to as negative interest) may arise on certain investments and you ask how these amounts may be characterized for purposes of the Income Tax Act (the “Act”).

The first scenario deals with negative returns arising on overnight cash deposits (“Deposits”) that are made with a financial institution (“ABC”).  ABC conducts a securities custody business with arm’s length clients in which it acquires and holds securities for its clients.  For the purposes of the submission, you ask that we assume that the clients hold the securities on account of capital. ABC also holds cash deposits for its clients, which may be denominated in Canadian dollars or a foreign currency.  The returns on the Deposits are calculated daily, and are generally equal to a rate of interest set by a relevant central bank less an agreed spread.  Statements recording the return on the Deposits are sent to clients monthly.  Custodial fees charged by ABC in respect of a client’s holdings and overdraft fees are each calculated and charged separately from the return on the Deposits.

In the examples submitted, the interest rate fluctuated during the course of the year such that in some months, positive interest accrued and in other months, there was negative returns on the Deposits.  In some cases, the positive interest would exceed the negative returns for the year and in other cases, the negative returns exceeded the positive interest for the year.  You ask how these negative returns would be characterized for income tax purposes.  For example, you ask whether a negative return is negative interest that offsets or reduces the positive interest or something else. Your view is that the negative return would be best characterized as a carrying charge in determining the taxpayer’s income under subsection 9(1) of the Act.  You also asked whether the negative returns on Deposits should be reported on information returns and slips.

The second scenario deals with a newly issued bond that has a negative yield (“negative yield bond”.)  In this scenario, a Canadian-resident taxpayer purchases a negative yield bond for $102 and will receive $100 when it matures in five years.  The bond does not pay or charge period interest.  You ask how the loss on the negative yield bond will be reported by the taxpayer in circumstances in which the bond is held on account of capital and in circumstances where it is held on account of income. In your view, where the bond is held on capital account, the $2 loss would be a capital loss at the time of disposition or on its maturity. Where the bond is held on income account, the $2 loss would be an income loss recognized on maturity or disposition.

Our Comments

This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.

Negative returns on overnight cash deposits

The CRA’s Folio S3-F6-C1, Interest Deductibility, indicates that an amount is considered to be interest if it represents compensation for the use of money, it is referable to a principal sum, and it accrues day-to-day.  In the scenario presented for the negative returns on overnight cash deposits, the client advances funds to ABC and instead of receiving compensation, the client incurs a cost by way of the negative return.  The negative return to the client would therefore not represent compensation for the use of money and would not constitute interest (or negative interest) to the client.  Accordingly, it is our view that the positive interest on the Deposits would not be offset or reduced by the negative returns.  Information returns and slips would be required to be prepared and issued by ABC with respect to the full amount of the positive interest in the normal manner for payments of interest.

Your view is that negative returns should be deductible in the calculation of net profit from property.  Subsection 9(1) provides that, subject to certain limits and conditions, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year. Paragraph 18(1)(a) stipulates that no deduction is permitted in respect of an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.  Subsection 9(3) confirms that “income” from property does not include capital gains or losses on the disposition of property.  Whether the income earning purpose test is met in a particular circumstance is a question of fact.  However, in the scenarios presented, it is our view that the client would have a reasonable expectation of earning interest income on the Deposits such that the limitation under paragraph 18(1)(a) would not apply.  Accordingly, the negative returns on the Deposits would likely be an eligible deduction in computing the client’s profits under subsection 9(1).

Negative yield bond

In respect of a taxpayer that purchased and held a newly issued negative yield bond on account of capital, that taxpayer would otherwise have a capital loss on its disposition or maturity.  However, pursuant to subparagraph 40(2)(g)(ii), that loss may be deemed to be nil unless it was acquired by the taxpayer for the purpose of earning income or as consideration for the disposition of capital property with whom the taxpayer was dealing at arm’s length.  The relevant portions of paragraph 40(2)(g) and subparagraph (ii) read as follows:

“(g) [Various losses deemed nil (superficial losses, etc.)] — a taxpayer’s loss, if any, from the disposition of a property…. to the extent that it is
[...]
(ii) a loss from the disposition of a debt or other right to receive an amount, unless the debt or right, as the case may be, was acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm’s length,
[…]
is nil;”

With respect to the example in which the negative yield bond was held on account of income, it is assumed that paragraph 18(1)(a) would not otherwise apply.  In such a case, we concur with your view that the loss on the bond would be recognized in the year of disposition or maturity as a loss on account of income.

Yours truly,

G. Moore
For Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2017

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2017