Convertible Debt: Foreign Exchange Gain

The Federal Court of Appeal recently issued its decision in the tax appeal by the Crown from the Tax Court of Canada's decision in favour of Agnico Eagle Mines Limited (Agnico) and determined that the foreign exchange gains arising on a conversion of US dollar-denominated convertible debentures issued by Agnico should be computed by comparing the Canadian dollar equivalent of the debentures as of the date of issuance of the debentures with the Canadian dollar fair market value of the shares into which the debentures were converted as of the date of conversion. This decision is at odds with the Tax Court decision, which concluded that no foreign exchange gain arose because the true consideration received on the issuance of the common shares was the subscription price paid for the debentures. The method of computing the foreign exchange gain mandated by the Court of Appeal resulted in a reduction/elimination of the foreign exchange gain assessed by CRA.

Issuers of foreign-denominated convertible debt should consider the tax and corporate consequences of issuing these securities in light of this case.

In 2002, Agnico issued approximately US$144M of $1,000 principal amount convertible debentures. At the time the debentures were issued, the Canadian dollar-US dollar exchange rate was C$1.588 to US$1.00, resulting in the Canadian dollar principal amount of the debentures being approximately $230M.

The debentures were redeemable by Agnico on or after February 15, 2006, for a redemption price equal to the principal amount plus accrued and unpaid interest and could be satisfied in Agnico common shares. Holders also had a conversion right, which entitled them to receive 71.429 common shares per convertible debenture at any time prior to redemption or maturity. In late December 2005, Agnico gave notice of its intention to redeem the debentures and satisfy the redemption price by issuing 63.4767 common shares per debenture. As a result, most holders exercised their conversion rights, since they were entitled to a greater number of common shares on conversion compared to on redemption.

Conversions occurred in 2005 and 2006 after the Canadian dollar had strengthened and when one US dollar was exchangeable for Canadian dollars which varied from 1.1443 to 1.1726. In the CRA's view, Agnico made aggregate foreign exchange gains on the conversions of approximately C$62M in 2005 and 2006. Such gains represented the Canadian dollar difference between the...