Global Tax Alert | 18 July 2013

Canada releases transitional measures regarding character conversion transactions

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On 11 July 2013, Canada’s Department of Finance released revised transitional measures applicable to the “character conversion” rules that were proposed as part of the 2013 federal budget.

Character conversion transactions involve certain financial arrangements that link a derivative investment with the purchase or sale of an otherwise unrelated capital property to form a derivative forward agreement.

Under the new rules, the taxpayer’s return from such an arrangement would get income account treatment – rather than capital account – with effect, originally, for agreements entered into after 20 March 2013, as well as agreements entered into before 21 March 2013 if the term of the agreement is extended after 20 March 2013.

The 11 July 2013 release announces a number of technical changes to the transitional rules applicable to these measures. In particular:

  • For arrangements involving short-term agreements, such as 30-day rolling forwards, the grandfathering period would be extended generally to the end of 2014 presuming certain growth limits contained in these measures are respected. In addition, for agreements entered into after 20 March 2013 and before 11 July 2013, there would be at least 180 days of grandfathering presuming a previous derivative forward agreement (DFA) was in place prior to 21 March 2013 and the respective growth limits are not adhered to.
  • For arrangements involving long-term agreements entered into before 21 March 2013, grandfathering would apply to transactions that occur before 22 March 2018. Again, such grandfathering is only available where the respective growth limits outlined in the proposals are respected.
  • The growth limits outlined under the transitional measures generally allow the cash committed to the fund before 21 March 2013 and for cash accumulated up to 10 July 2013 to be invested in the respective DFA, provided the increase in the notional amount post 21 March 2013 does not exceed 5% of the notional amount of the DFA immediately before 21 March 2013. Further allowable circumstances under the respective growth limits, but not limited by the 5% maximum, also include fluctuations in value in the underlying reference interest as well as investments in the DFA as a result of the exercise of an over-allotment option in respect of an offering of securities.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (Canada), Vancouver
  • Billie Raptis
    +1 604 891 8215
    billie.raptis@ca.ey.com
Ernst & Young LLP (Canada), Toronto
  • Joseph N. Micallef
    +1 416 943 3494
    joseph.n.micallef@ca.ey.com
  • Gary Chin
    +1 416 943 3427
    gary.chin@ca.ey.com
  • Jill Nicolson
    +1 416 943 4474
    jillian.nicolson@ca.ey.com
  • Reya Ali-Dabydeen
    +1 416 943 2220
    reya.ali-dabydeen@ca.ey.com
Ernst & Young LLP (Canada), Montréal
  • Benoît Millette
    +1 514 879 3562
    benoit.millette@ca.ey.com

EYG no. CM3653