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.
Principal Issues: Does the issuance of a new promissory note constitute a novation of the original promissory note such that subsection 15(2) of the Act will apply to the new loan/indebtedness?
Position: Yes.
Reasons: The issuance of a new promissory note, which replaces an existing promissory note, results in a new loan. The application of subsection 15(2) of the Act is determined whenever a shareholder receives a loan or becomes indebted to a corporation.
June 1, 2004
Linda Noble HEADQUARTERS
Verification and Enforcement A. Seidel, CMA
Toronto West Tax Services Office (613) 957-2058 2004-007717
Subsections 15(2) and 15(2.4) of the Act
This is in reply to your May 19, 2004 facsimile concerning the application of subsections 15(2) and 15(2.4) of the Income Tax Act (the "Act") in the following fact situation.
Background
1. XXXXXXXXXX are each employees of OPCO. HOLDCO owns XXXXXXXXXX% of the voting shares of OPCO.
2. Taxpayers XXXXXXXXXX collectively acquired a total of XXXXXXXXXX non-voting shares of OPCO on XXXXXXXXXX pursuant to OPCO's "Share Option Plan". OPCO provided a loan to each of XXXXXXXXXX to enable them to acquire the shares. XXXXXXXXXX each provided OPCO with a promissory note (the "Initial Promissory Notes").
3. By virtue of the exception in paragraph 15(2.4)(c) of the Act, subsection 15(2) of the Act did not apply to each of the XXXXXXXXXX loans from OPCO to each of XXXXXXXXXX.
4. On XXXXXXXXXX, pursuant to subsection 85(1) of the Act, each of XXXXXXXXXX exchanged their non-voting shares of OPCO for non-voting preferred shares of HOLDCO.
5. On XXXXXXXXXX , OPCO redeemed the XXXXXXXXXX non-voting shares held by HOLDCO for $XXXXXXXXXX. As a result of this redemption, the shares issued to XXXXXXXXXX in XXXXXXXXXX, pursuant to OPCO's "Share Option Plan", were no longer outstanding. The Initial Promissory Notes, however, were still payable to OPCO.
6. On XXXXXXXXXX, OPCO declared a dividend to HOLDCO and transferred the Initial Promissory Notes in payment of the dividend.
7. On XXXXXXXXXX, each of XXXXXXXXXX issued a new promissory note (the "New Promissory Notes") to HOLDCO. The terms and conditions of the agreement entered into with respect to the New Promissory Notes included the following:
"It has been determined that it would be in the best interests of all concerned to replace the Initial Promissory Note with this promissory note to reflect the amendments and the assignment of the Loan to "HOLDCO", so that the Indebtedness is now due and owing to "HOLDCO"."
"This promissory note is issued in substitution of and replaces the Initial Promissory Note so that from and after the date hereof the Initial Promissory Note ceases to evidence any obligations due and owing by the undersigned to "OPCO" and/or "HOLDCO", even though nothing herein and none of the transactions contemplated herein shall have the effect of reducing the obligations to pay the Indebtedness to "HOLDCO"."
Issue
The XXXXXXXXXX loans from OPCO were excluded from the application of subsection 15(2) of the Act by virtue of paragraph 15(2.4)(c) of the Act. The shares acquired with the proceeds of these loans were subsequently disposed of by XXXXXXXXXX but the Initial Promissory Notes remained outstanding. The Initial Promissory Notes were transferred to HOLDCO and on XXXXXXXXXX, they were replaced with loans from HOLDCO and the New Promissory Notes. The issue is whether the new loans from HOLDCO are subject to the application of subsection 15(2) of the Act.
The paragraph 15(2.4)(c) exception to subsection 15(2) of the Act refers to the creditor/debtor relationship that exists at the time of the issuance of the loan. A subsequent assignment of a loan to another person does not result in a new loan and a subsequent disposition of the shares acquired with the proceeds of the loan does not give rise to a new loan. Therefore, it is our general view that a loan that was previously exempted from the application of subsection 15(2) of the Act, because of paragraph 15(2.4)(c) of the Act, would continue to be exempt from the application of subsection 15(2) of the Act as long as the original loan remains outstanding.
However, where there has been a novation of an existing loan in exchange for a new loan, the application of subsection 15(2) of the Act is determined at the time that the new loan is received by the shareholder. In your particular situation, there was a novation of the original loans when HOLDCO and each of XXXXXXXXXX entered the new arrangement on XXXXXXXXXX. In our view, none of the exceptions in subsection 15(2.4) of the Act apply to the XXXXXXXXXX loans/indebtedness. Accordingly, subsection 15(2) of the Act would apply to each of the loans received by XXXXXXXXXX, respectively, on XXXXXXXXXX.
We hope our comments are of assistance. If you wish to discuss any of the above further, or if we can be of any further assistance, do not hesitate to contact us at the above number.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Randy Hewlett, B. Comm.
Section Manager
Business and Individual Section
Business and Partnerships Division
Income Tax Rulings Directorate
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