Tax Interpretations Judicial and CRA interpretations of Canadian tax law and transactional implications

13 November 2012
2012-0433941E5 E – Section 80 of the Income Tax Act (the “Act”)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Would the debt forgiveness rules in section 80 of the Act apply on inter vivos settlements of non-arm’s length obligations?

Position: Question of fact. Yes, in the scenario presented.

Reasons: The debt has been settled.

XXXXXXXXXX
John Parker CMA
2012-043394
Attention: XXXXXXXXXX

November 13, 2012

Dear XXXXXXXXXX:

Re: Application of the debt forgiveness rules on inter vivos settlements of non-arm’s length obligations.

We are writing in response to your letter of January 12, 2012, wherein you asked our opinion as to whether the debt forgiveness rules in Section 80 of the Income Tax Act (the “Act”) would apply on inter vivos settlements of non-arm’s length obligations. You provided us with the following facts of a hypothetical situation:

A father sold shares of a corporation to each of his children for non-interest bearing notes (the “Notes”) with a principal amount equal to the fair market value (“FMV”) of the shares. The father had recognized a capital gain for tax purposes on the gifting of the shares.

Upon the father’s death, the Notes were transferred under the father’s will to a spousal trust (the “Trust”) for the benefit of his wife. His spouse (the “Spouse”) is entitled to income and capital distributions of the Trust during her lifetime. The principal amount of the Notes is equal to the FMV of the Notes, and the Trust’s cost amount.

Your Position

The debt forgiveness rules contained in Section 80 of the Act do not apply to debts settled or extinguished by bequest or inheritance pursuant to paragraph 80(2)(a) of the Act. Debts settled through inter vivos gifts are not similarly exempted but as long as the fair market value of the obligation is equal to the principal outstanding, there will be no debt forgiveness consequences because there will be no forgiven amount.

The Spouse would be considered to have acquired the Notes from the Trust at their cost amount pursuant to subsection 107(2) of the Act which would be equal to their FMV.

The gifting of the Notes would result in deemed proceeds to the Spouse of FMV and an acquisition by the children at FMV pursuant to paragraph 69(1)(c) of the Act.

The Notes would be settled on acquisition by the children. The FMV of the Notes would equal the principal so there would be no forgiven amount and subsections 80(3) through subsection 80(13) of the Act would not apply so there would be no debt forgiveness consequences.

Our Comments

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, “Advance Income Tax Ruling”, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required. Such review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year. Nonetheless, we are prepared to offer the following general comments relating to the hypothetical situation.

Paragraph 80(2)(a) of the Act entitled “Application of debt forgiveness rules” states:

“For the purposes of this section,

(a) an obligation issued by a debtor is settled at any time where the obligation is settled or extinguished at that time (otherwise by way of a bequest or inheritance or as consideration for the issue of a share described in paragraph (b) of the definition “excluded security” in subsection (1));”

Therefore, had the Notes payable been extinguished by the terms of the father’s will, the debt forgiveness rules contained in section 80 would not have applied. However, the terms of the will did not reflect that the children’s debt was to be extinguished. Instead the Notes were transferred to the spousal Trust at FMV.

Subparagraph 107(2)(a) of the Act entitled “Distribution by personal trust” states: “Subject to subsections (2.001), (2.002) and (4) to (5), if at any time a property of a personal trust or a prescribed trust is distributed (otherwise than as a SIFT trust wind-up event) by the trust to a taxpayer who was a beneficiary under the trust and there is a resulting disposition of all or any part of the taxpayer’s capital interest in the trust,

(a) the trust shall be deemed to have disposed of the property for proceeds of disposition equal to its cost amount to the trust immediately before that time;”

You stated that, since the transfer of the Notes, from the Trust, to the Spouse was a return of capital and was to take place at FMV which was equal to the cost amount of the Notes, there would be no capital gain or loss. It was then the intention of the Spouse to gift the notes to the children. The notes would be settled on acquisition by the children.

IT-293R entitled “Debtor’s gain on settlement of debt” in para. 6 states: “For a debt or obligation to be “settled or extinguished” all liability for payment must be terminated. Payment, cancellation, set-off, substitution of debtors and release are examples of some possible means of settlement.”

In our opinion, once the Spouse gifted the notes to the children, there would be a settlement of debt. The liability to repay the notes has been extinguished. Therefore the forgiveness of debt rules would apply. Specifically, subsection 80(11) of the Act which would apply to reduce the ACB of the children’s shares by the amount of the forgiven amount.

We trust our comments will be of assistance.

Yours truly,

Doug Watson
for Director
Financial Industries Division
Income Tax Rulings Directorate