CRA indicates that it may not apply s. 80 where a trust distributes a debt, owing by a beneficiary, to the beneficiary [correction]

A Canadian resident trust makes a loan to a beneficiary, who uses the loan proceeds for investment purposes. Later, the trust distributes the loan as an in specie capital or income distribution to the beneficiary.

After noting that the extinguishment of the debt by operation of law (i.e., merger of the debtor and creditor) represented its settlement, CRA went on to indicate that since the extinguishment of the loan does not constitute a payment in satisfaction of the principal amount of the obligation, it would not reduce the forgiven amount under para. B(a) of the “forgiven amount” definition (respecting payments) nor would there be a reduction under any of the other paragraphs of the formula. Therefore, as a technical matter, this transaction would result in the debt forgiveness rules applying to the full loan amount.

However, CRA indicated that, in some specific situations, when a commercial obligation is extinguished by merger rather than by payment, it considers that there is not a forgiven amount for purposes of s. 80 and that it was of the view that this position would apply to the loan extinguishment in this example.

This suggests that the common practice of, for example, settling a debt owing by a parent to a subsidiary by distributing that debt to the parent (see, e.g., 2013-0498551R3), rather than making a distribution payable and then employing set-off, may be on somewhat shaky grounds. But what matters in the end is that CRA seems to be exercising its discretion not to apply s. 80.

Neal Armstrong. Summary of 15 June 2022 STEP Roundtable, Q.5 under s. 80(1) – forgiven amount – B(a).