CRA offers comfort with respect to withholding tax on convertible debentures

November 27, 2013

Convertible debentures have been and continue to be an extremely popular capital raising instrument in Canadian capital markets. Yesterday, Canada Revenue Agency (CRA) officials offered some long-awaited comfort to public company issuers of convertible debentures at the Canadian Tax Foundation’s annual conference in Toronto. As part of a roundtable discussion, CRA officials confirmed that there should not be any withholding tax arising on the conversion of a “standard convertible debenture” issued by a Canadian public corporation and held by a non-resident of Canada.

Since 2008, interest payments made by Canadian issuers to non-residents have generally not been subject to Canadian withholding tax unless the interest was “participating debt interest”, or the recipient did not deal at arm’s length with the issuer. In a ruling released by the CRA last year (2011-0418721R3– Convertible Notes), the CRA found that regular periodic interest payments on a convertible debenture issued by a Canadian public corporation would not constitute “participating debt interest”. However, uncertainty remained as to whether certain provisions of the Income Tax Act might deem a premium arising on the conversion of a debenture to be “participating debt interest” that would be subject to withholding tax. This uncertainty has generally forced corporate issuers to try to comply with specific conditions set out in the Income Tax Act and published by the CRA in order to ensure that their convertible debentures would be excluded from these deeming rules.

While these roundtable comments provide a welcome change, they do not go all the way in addressing the uncertainty surrounding withholding tax on convertible debentures. The comments were expressly limited to “standard convertible debentures” (as that term was defined in a letter from the Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants sent to the CRA in May 2010) issued by public corporations, such that some uncertainty will remain with respect to convertible debentures issued by trusts, partnerships, and private corporations. Nonetheless, even in these contexts, the comments should offer some comfort as there is no principled reason why the withholding tax rules should apply differently based on the nature of the issuer.  

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