3 October 2000 Internal T.I. 2000-0038637 - DEBT PARKING

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

1.Whether there has been a debt parking under subsection 80.01(8).

2.Whether a subsequent repayment deduction would be denied.

Position:

1.Maybe, if holder is non-arm's length with debtor
2.Don't know

Reasons:

1.The debt is a specified obligation ,a parked obligation (if ACO and ECO are non-arm's length) and the specified cost is less than 80% of principal amount.

2.Insufficient facts to suggest a deliberate parking in order to get a repayment deduction under subsection 80.01(10).

		October 3, 2000

	Vancouver Tax Services	HEADQUARTERS
	Section 442 - 21, SC 04	C. Savage
		957-8957
	Attention: Larry Moi
		2000-003863

Subsection 80.01(10) of the Income Tax Act (the "Act")

This is in reply to your memorandum of July 19, 2000, requesting our comments regarding the application of the debt forgiveness rules involving parked debt to a situation you are reviewing.

XXXXXXXXXX

You have concluded that this is a debt parking that results in a forgiven amount. In addition, you have concluded that the anti-avoidance rule in subsection 80.01(10) should apply to deny a deduction for any subsequent repayment of the forgiven amount. In your view, based on the numerous letters between the parties involved, the public knowledge concerning the new debt parking rules, the setting up of ECO to purchase the debt, and obtaining professional tax advice, it is reasonable to consider that one of the reasons for the debt parking was the opportunity for deductions in respect of future payments under the provisions of subsection 80.01(10) of the Act.

You have requested our opinion on whether your conclusions are technically sound.

Our Comments

Prior to the 1994 amendments to the debtor's gain rules in section 80 of the Act, it was possible to avoid the application of the forgiveness of debt provisions by having the debtor park the debt in question with a related party who had no intention of collecting the debt. For example, rather than forgiving the debt or allowing a settlement for less than the full amount, the creditor would sell the debt to a third party at a discount. The third party would then hold the debt without enforcing payment by the debtor such that there would be no settlement and no application of the provisions of section 80.

The Minister of Finance announced in the February 29, 1994 budget that certain changes would be made to the debt forgiveness provisions including, inter alia, changes to specifically address debt parking arrangements. The debt parking provisions are found in subsections 80.01(6) to (11) of the Act. Generally, these provisions deem a settlement of debt when a commercial debt obligation is sold by a holder that dealt at arm's length with the debtor to a person that does not deal at arms length with the debtor for an amount that is less than 80% of the principal amount of the obligation and therefore resulting in a forgiven amount. Where there is a subsequent payment on the forgiven amount, a deduction of three-quarters of the amount repaid may be allowed.

In order for the debt parking rules to apply to a commercial debt obligation at a particular time, the following conditions must be met:

• the debt must be a "specified obligation" within the meaning of subsection 80.01(6);
• the specified obligation must be a "parked obligation" within the meaning of subsection 80.01(7); and
• the "specified cost" to the current holder of the obligation is less than 80% of its principal amount as provided in the preamble to subsection 80.01(8) of the Act.

Since the former holder of the second mortgage dealt at arms length with the debtor, the second mortgage is a "specified obligation". On the assumption that (we can make no comment on this as it is a question of fact, it is being disputed by the taxpayer and you have not provided any information on this aspect) the current holder does not deal at arms length with the debtor, the second mortgage is also a "parked obligation". The amount paid by the current holder of $XXXXXXXXXX would be the specified cost of the second mortgage under subsection 80.01(1). Since the specified cost is less than 80% of the principal amount of $XXXXXXXXXX, paragraph 80.01(8)(a) of the Act applies to deem the obligation to have been settled at the particular time, and paragraph 80.01(8)(b) provides that the forgiven amount shall be determined as if the debtor paid an amount in satisfaction of the principal amount of the second mortgage equal to the specified cost of the second mortgage. Accordingly, we agree with your conclusion that the debt parking rules apply to the second mortgage on XXXXXXXXXX and that the forgiven amount would be approximately $XXXXXXXXXX.

When a debtor subsequently makes a payment on account of an obligation which was deemed to have been settled, subsection 80.01(10) allows a deduction from income. The deduction is generally 3/4 of the payment to the extent that it exceeds the portion of the principal amount of the debt that was not part of the forgiven amount. However, the deduction is available only where it cannot reasonably be considered that one of the main reasons that the obligation became a parked obligation was to have this subsection apply at a subsequent time. For example, a deduction may be denied in a situation where a debt was deliberately parked at a time when the debt forgiveness rules would of had a minimal effect on the debtor and therefore a subsequent repayment would have a more beneficial effect.

We have reviewed your comments on this and the correspondence concerning the negotiations between the interested parties. However, nothing that you have submitted enables us to conclude one way or the other that the anti-avoidance provision would or would not apply to deny a deduction of subsequent repayments under the provisions of subsection 80.01(10) of the Act. In particular, you have not provided any analysis of why the application of the debt parking rules and subsequent repayment would be more beneficial to the debtor than having the debt acquired by ACO directly nor have you provided any indication that payments were subsequently made on the parked debt. There is no indication that you have found any planning documents discussing this aspect of the transactions. ACO did not treat the debt as a parked obligation when it filed its tax returns. In order for a payment on a debt to be eligible for a deduction under subsection 80.01(10), the debt must previously have been deemed by subsections 80.01(8) or (9) to have been settled. If one of the main reasons the debt became a parked obligation was to have subsection 80.01(10) apply to allow a deduction for subsequent repayments, one would think that ACO would have filed on the basis that the debt was a parked obligation and recognized a forgiven amount. In our opinion, the fact that the debt was not treated as a parked obligation when it was acquired by ECO, lends support to the taxpayer's argument that the anti-avoidance rule does not apply.

We have not been provided with any explanation by the representatives as to why the debt was acquired by ECO rather than by ACO and BCO directly (i.e., why the debt became a parked obligation rather than a forgiven one). This is something you may wish to explore before you reassess.

It may appear obvious to you that, having the debt parking rules apply and having a partial deduction in the future should payments ever be made on the debt, that one of the main reasons the debt became a parked obligation must have been to have subsection 80.01(10) apply. If this is your opinion and you are satisfied that ECO and ACO dealt at non-arm's length, then you could proceed with the reassessment.

The application of the anti-avoidance provision in subsection 80.01(10) is a factual determination. Unfortunately, we have not been provided with the facts to make this determination one way or the other. We regret that our reply could not have been more helpful.

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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