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: Tax consequence of payment of amount to settle litigation regarding non-payment of promissory note to acquire partnership interest.
Position: Possibly capital loss on disposition of partnership interest and application of section 80, but would need to review documents to make determination.
Reasons: questions of fact and law
2001-006706
XXXXXXXXXX Denise Dalphy, LL.B.
(613) 957-9231
February 2, 2001
Dear XXXXXXXXXX:
Re: Taxation of Legal Settlement
We are writing in reply to your facsimile transmission of January 23, 2001 wherein you requested an opinion on the income taxation of an amount that was paid as a legal settlement.
Our understanding of the facts is as follows:
1. XXXXXXXXXX was (is) the general partner of a limited partnership (the "Partnership").
2. You invested as a limited partner in the Partnership in XXXXXXXXXX. The consideration that you provided to the Partnership in return for your interest as a limited partner in the Partnership was $XXXXXXXXXX cash and a promissory note in the amount of $XXXXXXXXXX (the "Promissory Note").
3. The Promissory Note was sold by the Partnership to XXXXXXXXXX.
4. You made annual payments, including interest and principal. The amounts paid each year varied from year to year.
5. The "partnership arrangement fell apart XXXXXXXXXX.
6. "The limited partners then voted in a new general partner for the project that recommended that limited partners do not make any further payments on the promissory notes."
7. "The bank filed a lawsuit against the limited partners XXXXXXXXXX.
8. In view of the high cost of continuing the legal action, on XXXXXXXXXX you settled with XXXXXXXXXX: in exchange for your agreement to pay $XXXXXXXXXX in total payments to XXXXXXXXXX during the year XXXXXXXXXX would cease the legal action against you. XXXXXXXXXX attributes $XXXXXXXXXX to interest and the remaining $XXXXXXXXXX to the original principal.
You have asked how you should account for this payment in your XXXXXXXXXX income tax return. You advise that you deducted - on line 221- the amounts that reflected the interest expense portion of amounts paid on the Promissory Note to XXXXXXXXXX in XXXXXXXXXX. You have also asked whether you can "claim" any of the principal amounts that you paid from XXXXXXXXXX on the Promissory Note.
Written confirmation of the consequences inherent in particular transactions are given by this directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R4, a copy of which is enclosed. Where the particular transactions are partially completed or completed, the enquiry should be addressed to the relevant Tax Services Office. We do not have copies of any of the Partnership Agreement that you entered into in XXXXXXXXXX or the Promissory Note that you provided to the Partnership. We also do not know whether (and if so, when) you have disposed of your interest in the limited partnership. This information is critical in ascertaining the income tax consequences, of the payment. The Tax Services Office may or may not decide to request our assistance in analyzing this information.
Notwithstanding the above, we are prepared to provide the following comments which are of a general nature.
The $XXXXXXXXXX that you paid to XXXXXXXXXX is not deductible in computing your income. When a person acquires an interest in a limited partnership, the cost of that interest is the legal consideration payable in order to receive that interest. In a situation where $5,000 must be paid in cash and $20,000 paid by way of a promissory note, the cost to the person of his or her interest in the partnership would be $25,000. Generally, unless one is in the business of buying and selling partnership interests, the interest that a person has in the partnership is classified as a capital property of that person, and in general terms, when the person sells, or otherwise disposes of his or her interest in the partnership, the difference between the cost to the person of that interest and the amount that the person actually receives (or is deemed by certain provisions of the Income Tax Act (the "Act") to receive) is included in income as a capital gain or deducted (only from capital gains) as a capital loss. (That is, usually no gain or loss on a person's interest in a partnership is recognized until that gain or loss is actually realized.) In your situation, it is not clear if or when you disposed of your interest in the Partnership.
Where part of the cost of a person's interest in a partnership included a promissory note which was not fully paid, but then satisfied upon the payment of an agreed amount, the amount that is forgiven (either principal or interest) may reduce the amount of a capital loss that would be claimed on the disposition of the partnership interest. The rules in the Act relating to forgiveness of debt are complex, and it would be necessary to analyse the relevant documentation to ascertain the exact income tax consequences. Similarly, with respect to the deduction of any amount of a settlement that represents the portion of the debt that is interest, it would be necessary to look to all circumstances to determine whether that amount is deductible. In very general terms, interest that was paid with respect to an amount that was borrowed by a person to acquire a partnership interest is not deductible if it is paid after the person disposed of the partnership interest. Since we are not aware of all of the relevant facts, we cannot comment on whether the interest component of the payment to XXXXXXXXXX will be deductible.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R4, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Customs and Revenue Agency. Our practice is to make this specific disclaimer in all instances in which we provide an opinion.
Yours truly,
Steve Tevlin
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Encl
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