2018-0779991C6 2018 CTF – Q13 - 20(1)(c) & Triangular Amalgamation

Principal Issues: Whether interest on borrowed funds, used to redeem preferred shares issued as part of a triangular amalgamation governed by subsection 87(9), is deductible under paragraph 20(1)(c)?

Position: Interest on borrowed money used to redeem the preferred shares is deductible under subparagraph 20(1)(c)(i) to the extent that the amount of the borrowed money does not exceed the capital of the shares redeemed that is computed prior to the redemption as described in paragraph 1.48 of the Income Tax Folio S3-F6-C1 on Interest Deductibility, and that the capital replaced by the borrowing was previously used for an eligible purpose of earning income from a business or property.

Author: Flisfeder, Anna
Section: 20(1)(c), 87(9)

2018 Canadian Tax Foundation Annual Conference

CRA Roundtable

Question 13: Deductibility of interest on borrowed funds used to redeem shares issued on a triangular amalgamation

Parentco, Subco and Targetco are taxable Canadian corporations. Parentco owns all of the outstanding shares of Subco. Parentco wishes to acquire all of the outstanding shares of Targetco from the shareholders of Targetco.

Targetco and Subco amalgamate in a triangular amalgamation governed by subsection 87(9) to form Amalco, which is wholly owned by Parentco after the amalgamation. In exchange for shares of Targetco, certain shareholders of Targetco receive preferred shares issued by Parentco on the amalgamation and other shareholders receive common shares of Parentco.

Preferred shares of Parentco issued on the amalgamation are redeemed for cash shortly after the amalgamation. In order to fund the redemption of the preferred shares of Parentco held by former Targetco shareholders, Parentco obtains a third party loan.

Is the interest on the third party loan, used by Parentco to redeem the preferred shares issued by Parentco as part of a triangular amalgamation governed by subsection 87(9), deductible under paragraph 20(1)(c)?

CRA Response

Subparagraph 20(1)(c)(i) provides that interest is deductible when there is an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer’s income) pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy).

Paragraph 1.48 of the Income Tax Folio S3-F6-C1 on Interest Deductibility (the “Folio”) indicates that interest expense on borrowed money used to redeem shares or return capital can be an exception to the direct use test. In connection with this use, the purpose test will be met if the borrowed money replaces capital (contributed capital or accumulated profits) that was being used for eligible purposes that would have qualified for interest deductibility had the capital been borrowed money.  Paragraph 1.49 of the Folio indicates that “where some proportion of shares is being replaced with borrowed money, only the capital of those shares, computed on a pro-rata basis, would be considered to be replaced with the borrowed money.”

Interest on borrowed money used to redeem the preferred shares is deductible under subparagraph 20(1)(c)(i) to the extent that the amount of the borrowed money does not exceed the capital of the shares redeemed that is computed prior to the redemption as described above, and that the capital replaced by the borrowing was previously used for an eligible purpose of earning income from a business or property.  In addition, in order for interest to be deductible under subparagraph 20(1)(c)(i), the amount of interest must be reasonable in the circumstances and there must be a legal obligation to pay interest.

A. Flisfeder
2018-077999
November 27, 2018

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, 2019

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, 2019