S. 20(1)(f) deduction unavailable where debt assumed (unless s. 248(26) available) (p. 18:12)
[P]aragraph 20(1)(f ) permits a deduction only to the original issuer of the debt. It appears that when a debt obligation is assumed by another taxpayer, neither the old nor the new debtor is entitled to a deduction in respect of the original issue discount,41 unless subsection 248(26) could potentially apply to put the new debtor in the same position as the old debtor for the purposes of paragraph 20(1)(f).
Apply s. 52(1) basis increase to avoid double-taxation of s. 20(14)(a) income inclusion (p. 18:14)
If an amount is included in computing a transferor’s income under paragraph 20(14)(a), no provision in the Act explicitly excludes that amount in the computation of the transferor’s gain or loss otherwise determined in respect of the disposition of the debt. In many cases, however, it would seem that an amount equal to this income inclusion could be added, under subsection 52(1), to the transferor’s cost of the debt. If this amount is added, double taxation should be avoided.
S. 20(14)(a) can apply even where rollover transaction or debt is underwater (p. 18:14)
[T]he application of subsection 20(14) does not depend on whether such interest is reflected in the value, or the amount otherwise determined to be the proceeds of disposition to the transferor or the cost to the transferee, of the assigned debt. For example, it would seem that subsection 20(14) could still apply in a scenario where a debt is “under water,” or even apply to a transfer that is a partially or wholly tax-deferred.
No s. 18(9.1) deduction for penalty incurred on disposition of property (p. 18:16)
[T]he CRA’s general view is that a penalty that is incurred in connection with the disposition of a property (for example, the repayment of a mortgage) is not considered to be made in the course of carrying on a business or earning income from property. Instead, the penalty is viewed as a cost incurred in respect of the disposition of the property, and it is included in computing the taxpayer’s gain or loss arising in respect of that disposition. [Footnote 65 See, for example, paragraphs 1.22 and 1.38 of … S4-F2-C1 … 2012-0436771E5 … and … 9325325 … .] It is not clear whether the CRA’s view depends on the purchase and sale agreement or on the terms of the underlying debt itself, terms that may require that the associated debt be repaid in connection with the sale of the property.
Hypothetical interest deduction (p. 18:16)
A penalty will qualify for deduction only if it can reasonably be considered to relate to, and does not exceed the value at the time of payment of the penalty of, the interest (that is, the “hypothetical interest value”) that would have otherwise been paid or payable by the taxpayer on the debt, in the absence of the repayment, for a taxation year ending after that time.
Potential requirement for the income-earning activity to continue (pp. 18:18-19)
When the debt constitutes borrowed money that has not been used to acquire property, the conditions for deductibility of the hypothetical interest value in a particular taxation year would appear to be met so long as the taxpayer is simply using the debt for an income-earning purpose at the time of repayment. It is not clear, however, whether this is the end of the story: any amount determined under subsection 18(9.1) would seemingly not be deductible in computing the income of the taxpayer, from a particular source, for a taxation year ending after the time of the penalty payment unless, or to the extent that, the taxpayer continues to carry on the particular income-earning activity that results in that source of income. … If, on the other hand, the taxpayer has used the funds from the debt to acquire property, there is clearly an ongoing requirement for the taxpayer to continue to own the property … if that property ceases to be used for an income-earning purpose, or if the taxpayer were to dispose of the property prior to the maturity of the debt and not replace it with another income-earning property, it would seem that the remainder of the hypothetical interest value would no longer meet the deductibility requirements in subsection 18(9.1).
Absence of symmetrical treatment if intermediary in back-to-back loan arrangement receives and pays a prepayment penalty (p.18:18)
[I]f an intermediary that is not a financial institution incurs a liability to fund the acquisition of a debt receivable, a situation could arise in which the early repayment of the debt receivable to the intermediary and the use of those proceeds by the intermediary to repay its liability could trigger the receipt, and the corresponding payment, of a penalty by the intermediary. In this case, the intermediary would generally include the penalty in computing its taxable income for the year of receipt, but it might not be able to claim an offsetting deduction—and might instead be limited to claiming a cost of disposition in computing its gain or loss arising in respect of the disposition of the debt receivable—for a penalty that is paid in respect of an early repayment of that liability, because the property to which the liability relates is no longer owned by the intermediary. Even if it was established that the amount is deductible, the penalty paid by the intermediary is only deductible over the remaining term of the liability had it not been repaid. Alternatively, if the intermediary is considered to be in the business of lending money, consideration could be given to whether the penalty paid might be deductible, under section 9 … . [I]t might be possible for the intermediary to avoid the payment and receipt of the prepayment penalty by assigning its debt receivable to the ultimate lender in satisfaction of the intermediary’s debt to the ultimate lender … .
Whether specific tracing or blended aggregate approach should be applied in determining s. 39(2) gain or loss on FX debt partial repayments (p. 18:19)
Aside from indicating the exchange rate(s) to be used, subsection 261(2) does not specify which particular advance or draw on an indebtedness is considered to be repaid for the purposes of determining the amount of any foreign exchange gain or loss that arises under subsection 39(2). Depending on whether one uses a specific linking or tracing approach, or whether one uses the pragmatic and probably more common approach of determining the unpaid balance in Canadian currency on the basis of a buildup of the applicable relevant spot rates for historical transactions, the partial repayment of a foreign-currency-denominated indebtedness could potentially yield a significantly different foreign exchange result to the debtor. …
It does not appear that the CRA has publicly commented on whether a specific tracing or blended aggregate approach is acceptable for the purposes of determining a gain or loss under subsection 39(2). However, in the context of the upstream loan rules in subsections 90(6) to 90(15), the CRA has indicated [in 2016-0673661I7] that it will follow a first-in, first-out (FIFO) method to allocate repayments in respect of multiple draws on a single facility, unless a specific designation is made to the contrary.
Textual interpretation suggests that the “amount” of debt for s. 219.1 purposes is its FMV (p. 18:20)
Pursuant to subsection 219.1(1), a corporation that emigrates from Canada is liable for tax (“departure tax”) equal to 25 percent of the amount, if any, by which the aggregate FMV of its properties before the emigration time exceeds the total of (1) the paid-up capital (PUC) of the corporation’s shares and (2) the total of all amounts each of which is “a debt owing by the emigrating corporation, or an obligation of the emigrating corporation to pay an amount, that is outstanding at that time.”
… “Amount” [as] defined in subsection 248(1) … is notably broad, and it refers in particular to the “value” of a right or thing. Combined with the fact that section 219.1 uses the term “amount” of a debt and not its “principal amount” … the text of subsection 219.1(1) suggests that the amount of a debt for departure tax purposes might not be intended to be limited to the principal amount of the debt.
Contrary interpretation could foster avoidance (pp. 18:20-21)
A purposive analysis of section 219.1 also appears to support the foregoing interpretation; if it did not, it appears that the application of the formula in section 219.1 might allow departure tax to be avoided, … [A] corporation borrows $100 with a fixed interest rate and lends the proceeds to another entity in the corporate group … . [I]nterest rates … increase, such that the corporation’s debts (both receivable and payable) have an inherent trading discount of $5. If the corporation emigrates from Canada at that subsequent time, it is relatively clear that the FMV of its debt receivable, for the purposes of subsection 219.1(1), should be $95. However, if the “amount” of the corporation’s debt obligation is equal to the principal amount of the debt ($100), it appears that the corporation could avoid departure tax for which it otherwise might be liable if the trading discount on the debt payable were taken into consideration, even though the net FMV of the debts receivable and payable, considered in isolation, is nil.
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