2024-1038261C6 2024 CTF Conference - Q.13 Standard Convertible Debentures and Part XIII Tax

Principal Issues:

1. Whether there is an excess under subsection 214(7) on the conversion of standard convertible debentures issued by Canadian public entities (taxable Canadian corporations, trusts resident in Canada, Canadian partnerships) when the FMV of the common shares received exceeds the price paid for the convertible debentures.

2. Whether the deemed payment of interest on standard convertible debentures under subsection 214(7) that arises because of a transfer or assignment constitutes participating debt interest.

Position:

1. Yes.

2. No.

Reasons:

1. Wording of subsection 214(7), TCP analysis, 214(7) applicable from the perspective of the holders of standard convertible debentures.

2. Previous position.

Author: Gagnon, Robert
Section: 214(7), 212(3)

2024 CTF Annual Conference

CRA Round Table

Question 13: Standard Convertible Debentures and Part XIII Tax


In its response to question 12 at the CRA Round Table at the May 2009 IFA Seminar (note 1), the CRA said that where there is a conversion of a traditional convertible debenture (as described in the response) by its original holder for common shares of the capital stock of the issuer, there would generally be no excess under subsection 214(7) (the CRA’s Administrative Position).

In its May 10, 2010 letter of submissions (note 2), the Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada stated that the conversion premium realized on conversion or sale of a convertible debenture would constitute an excess (the amount by which the price for which the obligation was assigned or otherwise transferred exceeds the price for which the obligation was issued) under subsection 214(7).

In its response to question 16 at the CRA Round Table at the 2021 CTF Annual Conference (note 3), the CRA said that it had to review the CRA’s Administrative Position concerning the application of subsection 214(7) to the conversion of convertible debentures in light of new information available.

What is the status of the review mentioned by the CRA at the 2021 CRA Round Table?

CRA Response

In our view, the CRA’s Administrative Position is difficult to justify in light of the wording of paragraph 214(7)(d) and the provisions of indentures of standard convertible debentures issued by public entities.

Consequently, the CRA’s position is now that where there is a conversion of a standard convertible debenture issued by Canadian public entities (taxable Canadian corporations, trusts resident in Canada, Canadian partnerships), there is in general an excess under subsection 214(7) equal to the amount (if any) by which the fair market value of the common shares received on the conversion (i.e. the price for which the standard convertible debenture was assigned or otherwise transferred at that time) exceeds the price for which the standard convertible debenture was issued (the CRA’s New Position).

The CRA’s New Position will be applicable on a prospective basis for standard convertible debentures issued after December 3, 2024.

Definition of “Participating Debt Interest”

The CRA’s view is still (note 4) that the deemed payment of interest on standard convertible debentures under subsection 214(7) that arises because of a transfer or assignment by a non-resident person to a person resident in Canada (including the issuer of the debentures) of standard convertible debentures issued by Canadian public entities (taxable Canadian corporations, trusts resident in Canada, Canadian partnerships), does not generally constitute “participating debt interest” (as defined in subsection 212(3)).

The CRA cannot provide certainty concerning the application of part XIII tax to all the situations in which convertible debentures can be issued (note 5). They can be issued by corporations (public and private), trusts and partnerships. Their terms and conditions can be complex due to the wide variety of products available in the marketplace, and the particular circumstances and the terms and conditions of the debentures may differ from one situation to another.

As a result, it is not possible for the CRA to anticipate the result of the application of subsection 214(7) and the definition of “participating debt interest” in subsection 212(3) with respect to all possible situations involving convertible debts.

The Income Tax Rulings Directorate (ITRD) continues to encourage issuers and/or holders of convertible debts to request advance income tax rulings if they have concerns about the application of part XIII of the Act to convertible debts in the context of proposed transactions. Provided that a ruling request is received prior to the issuance of the convertible debts, ITRD will examine the request, and the rulings would generally apply prospectively to future regular periodic interest payments, conversions, or sales of convertible debts.



Robert Gagnon
2024-103826
December 3, 2024

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 CRA document no. 2009-0320231C6, May 1, 2009.

2 Joint Committee on Taxation of the Canadian Bar Association and Chartered Professional Accountants of Canada, “Re: Convertible Debentures,” submission to the Canada Revenue Agency, Income Tax Rulings Directorate, May 10, 2010.

3 Question 16 “Convertible Debentures and Part XIII Withholding Tax”, CRA document 2021-0911911C6, November 25, 2021.

4 Supra, note 3.

5 “Question 9: Part XIII Tax in Respect of Convertible Debentures”, CRA document 2013-0509061C6, November 26, 2013.

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