2002 Ruling 2001-0095583 - 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.

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

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

Principal Issues:

Whether X Co. will be entitled to claim a deduction pursuant to section 61.3(1) of the Act in respect of amounts included in the income of X Co. pursuant to subsection 80(13) of the Act as a result of the forgiveness of debts formerly owing to Y Co.

Position: Favourable ruling given.

Reasons: Requirements of the law are met

XXXXXXXXXX        2001-009558

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling - XXXXXXXXXX

We are writing in response to your correspondence of XXXXXXXXXX, and the additional information submitted on XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of XXXXXXXXXX.

To the best of your knowledge, and that of the taxpayer involved, none of the issues contained herein are:

(i) dealt with in an earlier return of the taxpayer or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

DEFINITIONS

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended, (the "Act") to the date hereof, and, all references to a statute are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated;

(b) "X Co." means XXXXXXXXXX.

(c) "Y Co." means XXXXXXXXXX.

STATEMENT OF FACTS

1. X Co. is a corporation, incorporated under the Canada Business Corporations Act (the "CBCA"), which formerly carried on business in the XXXXXXXXXX. X Co. is not exempt from tax under Part 1 on its taxable income.

2. X Co.'s address is XXXXXXXXXX and is resident in Canada.

3. The tax returns of X Co. are handled by the XXXXXXXXXX Taxation Services Office and the XXXXXXXXXX Taxation Centre.

4. The outstanding shares of X Co. are currently held by the following parties:

XXXXXXXXXX.

5. Although X Co. enjoyed commercial success in the past, the company encountered severe financial difficulties during XXXXXXXXXX and began to sustain significant losses thereafter.

6. In XXXXXXXXXX, Y Co. exercised its right under a Pledge Agreement between Y Co. and X Co. to utilize the voting privileges attached to the shares of X Co. pledged thereunder in order to acquire ownership of XXXXXXXXXX% of the common shares of X Co.

7. In XXXXXXXXXX, X Co. recognized that the prospects of a full financial recovery were extremely limited and accordingly, the corporation initiated the process of ceasing its business activities.

8. In the years subsequent to XXXXXXXXXX, all of X Co.'s assets were sold. The audited financial statements of X Co. for the year ending XXXXXXXXXX, confirm that X Co. has no assets, liabilities in the amount of $XXXXXXXXXX; stated capital and contributed surplus of $XXXXXXXXXX and a deficit of $XXXXXXXXXX.

9. As of XXXXXXXXXX, Y Co.'s loans to X Co. are as follows:

Secured notes, XXXXXXXXXX , non-interest bearing            $ XXXXXXXXXX
with no specific terms of repayment
Secured notes, XXXXXXXXXX , non-interest bearing            $XXXXXXXXXX
With no specific terms of repayment
                               $XXXXXXXXXX 

Y Co. term loan, non-interest bearing with no specific terms $ XXXXXXXXXX
of repayment
Y Co. term loan, non-interest bearing with no specific terms $XXXXXXXXXX
of repayment
Y Co. term loan, non-interest bearing with no specific terms $ XXXXXXXXXX
of repayment
Y Co. term loan, non-interest bearing with no specific terms $ XXXXXXXXXX
of repayment
Y Co. indebtedness and operating loan, non-interest bearing $ XXXXXXXXXX
Total Loan Balance $XXXXXXXXXX

As of XXXXXXXXXX, the "Total Loan Balance" is $XXXXXXXXXX.

10. The loans and the relationship between X Co. and Y Co. all predate February 21, 1994.

11. Y Co. currently has loans outstanding to X Co. in the amount of $XXXXXXXXXX. Y Co. has written off all such loans but has not forgiven the loans or released its security position with respect to those debt obligations.

12. The "forgiven amount", as defined in subsection 80(1), will equal the "Total Loan Balance" at the time the debts will be forgiven.

13. Y Co.'s cost amounts in both the shares in X Co. pledged under the Pledge Agreement and the debts owed by X Co. to Y Co. are nil. The fair market value of Y Co.'s loans is effectively nil.

14. At XXXXXXXXXX, X Co. had non-capital losses of XXXXXXXXXX As of XXXXXXXXXX, X Co. also had net capital losses of $XXXXXXXXXX.

15. Until XXXXXXXXXX, each loan (other than Y Co. indebtedness and operating loan) carried an obligation to pay interest. Effective XXXXXXXXXX, Y Co. forgave the interest then due by X Co. and all loans became non-interest bearing. The loans were not considered to have been disposed of at that time and as a consequence, X Co. did not report a disposition in its income tax return for the relevant taxation year.

16. It is the desire of the shareholders of X Co. to dissolve the corporation in the near future. However, in accordance with the relevant provisions of the CBCA, to effect a dissolution of X Co., the corporation must not have any outstanding obligations that exceed the value of its assets.

PROPOSED TRANSACTION

17. In order to facilitate the contemplated dissolution of X Co., Y Co. will forgive all of the debts owing from X Co. to Y Co. Upon the forgiveness of the debts owing from Y Co. to X Co., all of X Co.'s liabilities to Y Co. will have been eliminated.

18. As a consequence of X Co.'s debts being forgiven by Y Co., the following tax results are expected to occur:

Subsection 80(2) of the Act will apply to establish that an obligation will be settled at any time where the obligation is settled or extinguished at that time. Pursuant to subsection 80(3) of the Act, the forgiven amount will be applied to reduce the noncapital loss carryforward of $XXXXXXXXXX to nil. Pursuant to subsection 80(4) of the Act, to the extent that the forgiven amount exceeds the noncapital loss referred to in subsection 80(3), the remaining balance of the forgiven amount will be applied to reduce the net capital loss carryforward of $XXXXXXXXXX to nil. Pursuant to the computation in subsection 80(13) of the Act, 50% of the unapplied portion of the forgiven amount will be included in X Co.'s income by virtue of paragraph 12(1)(z.3) of the Act. X Co. will be entitled to deduct an amount equal to an income inclusion under subsection 80(13) to the extent that the value of the relevant inclusion exceeds twice the fair market value of the corporation's assets at the end of the relevant taxation year. Since X Co. has no assets, the full amount of any income inclusion under subsection 80(13) will be deductible pursuant to subsection 61.3(1) of the Act.

19. Following the completion of the above-mentioned proposed transactions, under the relevant provision of the CBCA, Y Co. will cause the dissolution of X Co.

PURPOSE OF THE PROPOSED TRANSACTION

20. Y Co. has been carrying the unrecoverable costs of the share equity and debts owed by X Co. in its books and records since the business was discontinued in XXXXXXXXXX. The losses sustained by Y Co. have been written off for a number of years. The purpose of the proposed transaction is to write off the obligations owed by X Co. to Y Co. with a view to dissolving X Co. under the CBCA.

RULINGS GIVEN

Provided that the above statements are accurate and constitute a complete disclosure of all of the relevant facts, proposed transactions, and the purpose of the proposed transactions and provided that the proposed transactions are carried out as described above, our rulings are as follows:

A. The forgiveness of X Co.'s obligations by Y Co., which is the "Total Loan Balance" described in paragraph 9, will constitute a settlement or extinguishment of those obligations at that time for the purposes of subsection 80(2).

B. Provided that X Co. has an income inclusion under paragraph 12(1)(z.3), as computed under subsection 80(13), it will be entitled to claim a deduction, up to the maximum permitted, under subsection 61.3(1), in the taxation year in which the income inclusion under paragraph 12(1)(z.3) and subsection 80(13) occurs.

These rulings are provided subject to the limitations and qualifications set out in Information Circular 70-6R4 issued by the Canada Customs & Revenue Agency on January 29, 2001, and are binding upon the Agency provided that the proposed transactions are completed on or before XXXXXXXXXX. The rulings are based on the Income Tax Act and Regulations in their present form and do not take into account the effects of any proposed amendments thereto.

Nothing in this letter should be construed as confirmation, express or implied, that the Agency has reviewed or is making a determination or ruling in respect of any other tax consequences arising from the facts or proposed transaction described above other than those specifically confirmed in the rulings given.

Yours truly,

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