12 August 2010 External T.I. 2010-0370991E5 - Debt forgiveness

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: Tax implications of debt forgiveness between two corporations owned 50/50 by the same two individuals.

Position: General information provided.

XXXXXXXXXX
									2010-037099
									Andrea Boyle, CGA
August 12, 2010

Dear XXXXXXXXXX :

Re: Debt Forgiveness

I am replying to your letter dated June 8, 2010, in which you asked about the forgiveness of a debt between two corporations. The facts as you have described them are as follows:

• There are two corporations each of which is owned 50% by the same two individuals.
• Corporation A, an operating company, lent money to Corporation B, a holding company which Corporation B used to purchase a building.

You have asked whether, in the above situation, it is acceptable for Corporation A to forgive the debt to Corporation B.

The particular situation outlined in your letter appears to relate to a factual one, involving specific taxpayers. Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. We are, however, prepared to offer the following general comments, which may be of assistance.

All statutory references in this letter are references to the provisions of the Income Tax Act, R.S.C. 1985 (5th supp.) c. 1, as amended.

The Income Tax Act does not govern whether or not debt can be forgiven between related parties. There are, however, potential tax consequences on the forgiveness of the debt.

Lender

The forgiveness of a debt is generally considered to be a disposition of property. Subparagraph 40(2)(g)(ii) deems a loss on the disposition to be nil unless the debt was acquired for the purpose of gaining or producing income from a business or property. It is a question of fact whether a particular debt was acquired for the purpose of earning income from a business or property. In order to make such a determination, it is necessary to review all the relevant facts and documents surrounding a particular situation. For example, in our view, money which has been loaned at a reasonable rate of interest generally constitutes a debt acquired for the purpose of gaining or producing income, and any loss which arises on settlement is generally not deemed to be nil by virtue of paragraph 40(2)(g)(ii).

Even when a debt was acquired for the purpose of earning income from a business or property, subparagraph 69(1)(b)(i) presumes, except as expressly otherwise provided in the Act, that where a taxpayer disposes of anything to a person with whom the taxpayer was not dealing at arm's length for less than the fair market value thereof, the taxpayer shall be deemed to have received proceeds of disposition equal to that fair market value. Under the definitions in 251(1) and (2), two corporations are related if the corporations are each controlled by the same group of persons and, in that case, the corporations would be deemed not to deal with each other at arm's length. As a result, in this situation, the deemed proceeds of disposition would be the fair market value of the loan which could mean that no loss on the disposition of a debt would be allowed to the lender.

Debtor

Section 80 of the Act applies when certain "commercial debt obligations" of a debtor are settled or extinguished for an amount less than the principal amount of debt. Under this section, the forgiven amount is applied in a specified order to reduce certain tax balances of the debtor corporation or included in the debtor's income.

Generally, commercial debt obligations are debt obligations incurred for the purpose of earning income from a business or property. More specifically, under the definition in 80(1), a "commercial debt obligation" means a debt obligation issued by the debtor where interest was paid or payable by the debtor in respect of it pursuant to a legal obligation, or if interest had been paid or payable by the debtor in respect of it pursuant to a legal obligation, an amount in respect of the interest was or would have been deductible in computing the debtor's taxable income. Therefore if interest on the particular debt is not (or would not be) deductible, the debt forgiveness provisions under section 80 will not apply.

Assuming that section 80 applies and the debt is settled or extinguished for an amount less than the principal amount of the debt, the forgiven amount would be the principal amount of the debt outstanding and the tax balances of Corporation B would be reduced in the order as described in 80(2)(c):

• under 80(3) the forgiven amount must be applied to reduce carryover losses of the debtor (in order: non-capital losses other than allowable business investment losses, farm losses, restricted farm losses, allowable business investment losses, and net capital losses);
• under 80(4) and (5) the debtor has the option to apply the forgiven amount to reduce the capital cost of certain depreciable property;
• under 80(6) to (11) the debtor has the option to apply the forgiven amount to reduce the adjusted cost base of certain capital property;
• Under 80(13) any remainder of the forgiven amount (after some further potential adjustments) is included in income generally at the capital gains inclusion rate.
• Finally, under section 61.4, if the debtor is a Canadian resident corporation, a reserve can be claimed on any income inclusion which would allow a corporation to spread out the income inclusion on the debt forgiveness over five years.

Where section 80 of the Act does not apply, they are no immediate income tax implications to the debtor corporation due to the forgiveness of the debt.

Since your situation involves the interpretation of relatively complex provisions of the Act, you may wish to consider obtaining professional advice in order to best plan your tax affairs.

We trust that these comments will be of assistance.

Yours truly,

Randy Hewlett
Manager
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch