10 April 2003 External T.I. 2002-0170485 - Assumption of Debt

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 paragraph 85(1)(b) applies to a situation where a corporation pays an amount owing to a shareholder by assuming a debt owing by the shareholder, even if the affect of that assumption of debt is to reduce the debt that must be assumed by the corporation on a subsequent transfer of property to the corporation?

Position: No.

Reasons: Providing that there is a genuine pre-existing amount owing by the corporation to the shareholder, paragraph 85(1)(b) will not apply to increase the elected amount because the corporation assumes the debt as a repayment of the previous debt.

XXXXXXXXXX 2002-017048
F. Francis
April 10, 2003

Dear XXXXXXXXXX:

Re: Paragraph 85(1)(b) of the Income Tax Act (the "Act")

This is in reply to your letter of October 25, 2002, wherein you requested our comments with respect to the application of paragraph 85(1)(b).

At the 2000 Canadian Tax Foundation Conference, the Canada Customs and Revenue Agency announced a change in the administrative position relating to the application of paragraph 85(1)(b) in a situation where there is a transfer of property with liabilities in excess of cost amount and the excess is allocated to another property or is assumed by the purchaser in consideration for the delivery by the vendor of a promissory note in the amount of the excess. It is our position that, if the total non-share consideration so considered to have been given by the purchaser for the property exceeds the amount agreed upon by the vendor and purchaser in their election under subsection 85(1), paragraph 85(1)(b) will apply to increase the amount agreed upon.

You would like us to confirm that paragraph 85(1)(b) will not apply to a situation in which a corporation pays an amount owing to a shareholder, by assuming a debt owing by the shareholder, even if the effect of that assumption of debt is to reduce the debt that must be assumed by the corporation on a subsequent transfer of property to the corporation.

To illustrate your question, you present the following situation:

1. Shareholder S is the sole shareholder of corporation C.

2. Corporation C owes $100 to shareholder S.

3. Shareholder S owns a property with a tax cost of $200 and a FMV of $300. The property is encumbered by debt with a principal amount of $275.

4. S wishes to transfer the property to C under subsection 85(1). However, such a transfer would result in a minimum elected amount of $275.

5. If C had sufficient cash, C would be able to pay $75 to S and S could use that $75 to reduce the debt on the property from $275 to $200. S could then transfer the property to C and elect at the tax cost of $200.

6. Another alternative would be for C to assume $75 of the debt owing by S as a partial payment of the $100 amount owing by C to S. This would enable S to transfer the property to C under subsection 85(1) and elect $200 as the elected amount. C would issue shares to S for the balance of the consideration.

In view of the fact that C is assuming $75 of the debt as a partial repayment of the amount owing to S, you submit that paragraph 85(1)(b) should not apply to increase the elected amount in respect of the subsequent transfer of the property. We confirm your interpretation in a situation where there is a genuine pre-existing amount owing by the transferee corporation to the shareholder.

The above comments are an expression of opinion and, as noted in Information Circular 70-6R5 issued on May 17, 2002, are not binding on the Canada Customs and Revenue Agency.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
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