6 November 2002 External T.I. 2002-0150635 - FORGIVEN AMOUNT FOREIGN CURRENCY

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 forgiveness of debt in particular situation

Position: no-

Reasons: 80(2)(k)

		2002-015063
XXXXXXXXXX 	Denise Dalphy, LL.B.
(613) 941-1722
November 6, 2002

Dear XXXXXXXXXX:

Re: Settlement of Debt Obligation Redenominated in Foreign Currency

We are writing in reply to your letter dated July 4, 2002 wherein you requested a technical interpretation with regard to the treatment of a debtor under section 80 of the Income Tax Act (the "Act") on the settlement of a debt obligation after the obligation was redenominated from Canadian dollars to a foreign currency.

Our understanding of the hypothetical fact situation is as follows:

1. A corporation resident in Canada (the "Debtor") borrows Can$ 10,000 from a related corporation resident in Canada (the "Lender") under the terms of an agreement (the "Debt Agreement") on a demand basis. At the time of the issue of the Debt Obligation ("Time 1"), US$1 =Can $1. You have asked us to assume that the obligation (the "Debt Obligation") issued by the Debtor is a "commercial debt obligation" within the meaning assigned by subsection 80(1) of the Act.

2. Under the terms of the Debt Agreement, the Debt Obligation is payable in Canadian dollars without any interest. However, the Debtor may, at any time while the Debt Obligation is outstanding, elect for the Debt Obligation to become payable in U.S. dollars. The exchange rate in respect of the redenomination corresponds to the Canadian/U.S. dollar exchange rate at the time of the redenomination.

3. Some years after Time 1 ("Time 2"), pursuant to the terms of the Debt Agreement, the Debtor elects that the Debt Obligation be redenominated to U.S. dollars. At Time 2, U.S.$1 = Can$1.25, with the result that the Debt Obligation becomes U.S.$8,000.

4. Some years after Time 2 ("Time 3"), the Debt Obligation is settled by a payment of U.S.$8,000 from the Debtor to the Lender. At Time 3, U.S.$1 = Can$0.95.

5. For the purposes of this response, you have asked us to assume that no new obligation was created on the redenomination described in paragraph 2 above.

Our Comments

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 70-6R5. Where the particular transactions are partially completed or completed, the enquiry should be addressed to the relevant Tax Services Office. Notwithstanding the foregoing, we are providing the following comments.

"[F]orgiven amount" is defined as follows in subsection 80(1) of the Act:

"forgiven amount" at any time [emphasis added] in respect of a commercial obligation issued by a debtor is the amount determined by the formula:

A-B

where

A is the lesser of the amount for which the obligation was issued and the principal amount of the obligation
and
B is the total of

(a) the amount, if any, paid at that time in satisfaction of the principal amount of the obligation, ..."

Subsection 248(1) of the Act defines "principal amount" in relation to any obligation as the "maximum amount ... payable on account of the obligation by the issuer thereof ...". This provision is somewhat ambiguous in that it doesn't refer to "unpaid principal amount", "principal amount outstanding", or "original principal amount".

We consider that the following factors are significant in applying this definition to the situation described above:

1. Variable "A" in the definition of "forgiven amount" in subsection 80(1) of the Act refers to two amounts (1) the "amount for which the obligation was issued" and 2) the "principal amount of the obligation"), and it is implicit that the amounts need not always be the same;

2. Paragraph (a) in variable "B" in the definition of "forgiven amount" in subsection 80(1) of the Act refers to "the amount, if any, paid at that time in satisfaction of the principal amount of the obligation". It does not refer to "amounts previously paid in satisfaction of the obligation". (Therefore it is implicit that the "principal amount of the obligation" at the time when it is settled may be a different amount than the "amount for which the obligation was issued", and "the principal amount of the obligation" in this provision of the Act is not necessarily the maximum amount payable on the obligation at any time, but is the maximum amount payable at the time when the definition is utilized); and

3. There are no explicit timing provisions with respect to the determination of the "principal amount of the obligation" in Variable A of the definition of "forgiven amount". However, the definition provides that the determination may be made "at any time", and Variable B in this definition refers to the same time ("amounts, if any, paid at that time...").

In our view, based on the scheme of the Act and the debt forgiveness rules, the phrase "principal amount of the obligation" in variable "A" of the definition of "forgiven amount" in subsection 80(1) of the Act should be interpreted as the maximum amount that is payable on the debt obligation at the time when the "forgiven amount" is computed [emphasis added].

While the "principal amount" of the Debt Obligation at the time when it was issued (the amount for which the obligation was issued) was Can$10,000, the "principal amount" at the time of applying this definition (Time 3) was US$8,000. Since, this amount (US$8,000) is not denominated in Canadian currency, paragraph 80(2)(k) of the Act applies. Paragraph 80(2)(k) of the Act provides: "...the forgiven amount at any time shall be determined with reference to the relative value of that currency and the Canadian currency at the time the obligation was issued" [emphasis added]. As such, the "principal amount" of the Debt Obligation at Time 3 ("at any time") must be determined using the Canadian exchange rate at Time 1 (the "time when the obligation was issued"), when US$1 = Can$1. Therefore, in the above example, the "principal amount" of the Debt Obligation for that time is Can$8,000.

Paragraph (a) in variable B in the definition of "forgiven amount" is the amount "paid in satisfaction of the principal amount of the obligation". In the above hypothetical situation, this amount, US$8,000, must, also, pursuant to paragraph 80(2)(k) of the Act, be restated using the rate of exchange at Time 1: Can$8,000.

Finally, we agree that the foreign currency gains and losses for a debtor and creditor are taken into account under income tax rules, quite apart from the debt forgiveness rules.

The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, 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
Manager
Corporate Financing Section
Financial Industries Division
Income Tax Rulings Directorate