29 May 2008 Internal T.I. 2007-0235211I7 - Capital Cost Allowance-Bankruptcy-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.

Principal Issues: (1). Whether a bankrupt individual can continue to claim CCA on assets under his control while bankrupt.

(2). If the individual ceases operations at a later date, whether he or she can claim a terminal loss.

(3). Whether the UCC be adjusted by the forgiven debts that specifically relate to a specific asset or any asset.

(4). Whether forgiven credit card debt, used to purchase depreciable assets, fall under the debt forgiveness rules.

Position: (1). Yes.

(2). Yes.

(3). No.

(4) No.

Reasons: A bankrupt individual, in possession of assets under his or her control, may claim capital cost allowance or a terminal loss on assets acquired before he or she was adjudged bankrupt. The debt forgiveness rules do not apply to a bankruptcy.

 								May 29, 2008

	EDMONTON TSO					HEADQUARTERS											Income Tax Rulings
	Attention:  Carol Sayre	  			Directorate
								Lindsay Frank
(613) 948-2227

								2007-023521

Capital Cost Allowance – Bankruptcy – Debt Forgiveness

This is in reply to your email, concerning the interplay between the provisions of the Income Tax Act and the Bankruptcy and Insolvency Act, as they relate to the above-referenced matters.

Specifically, you are seeking answers to the following questions:

1. Can a bankrupt individual continue to claim capital cost allowance on assets under his control?

2. If the individual ceases operations at a later date, can he or she claim a terminal loss?

3. Would the undepreciated capital cost be adjusted by the forgiven debts that specifically relate to a specific asset or any asset?

4. Would forgiven credit card debt, used to purchase depreciable assets, fall under the debt forgiveness rules?

Our Comments

As explained below, a bankrupt individual may claim capital cost allowance or a terminal loss on assets acquired before being adjudged bankrupt, where such assets did not vest in the trustee. In addition, the debt forgiveness rules do not apply in a bankruptcy.

Pursuant to subsection 71(2) of the Bankruptcy and Insolvency Act (“BIA”), the onset of a taxpayer’s bankruptcy causes that person’s property, subject to the rights of a secured creditor, to vest in the trustee in bankruptcy (“trustee”) appointed to administer the bankrupt estate. However, paragraph 67(1)(b) of the BIA precludes assets, exempt from seizure, from such vestiture. You have indicated that the assets at issue involve a motor vehicle and tools of the trade.

Bankruptcy can result in the taxpayer’s release from claims provable by creditors. In this respect, the BIA can compel creditors to settle or forgive the amounts owing, and it is the trustee’s responsibility to determine the extent of the amount to be settled or forgiven. This would depend on the dividend that the creditors would receive from the estate, stemming from the trustee’s realisation on the liquidation of the bankrupt’s property under his or her control. That amount would be net of the costs of administering the estate.

Section 80 of the Income Tax Act (“the ITA”) contains the debt forgiveness rules, which apply when a taxpayer settles a commercial debt, or when that debt is settled or extinguished. A commercial debt is generally a debt where, if interest was paid or was payable, or if it had been payable, that interest would have been deductible. Ordinarily, a commercial debt is settled or extinguished when a creditor forgives or releases a taxpayer from paying some or all of the debt, or when a creditor can no longer, by operation of law, enforce collection of the debt. Such collection could be statute-barred, or stayed as a result of the taxpayer’s discharge from bankruptcy. Subsection 178(2) of the BIA releases the bankrupt taxpayer from claims provable in bankruptcy.

A key element in section 80 of the ITA is the definition of forgiven amount in subsection 80(1). In this respect, paragraph (i) of the description B in that definition eliminates the principal amount of a commercial obligation, extinguished in the bankruptcy, from the application of the debt forgiveness rules in a bankruptcy. Therefore, the debt forgiveness rules would have no bearing on the undepreciated capital cost of the assets of the bankrupt.

Overall, the debt forgiveness rules stipulate that the amount of the forgiven debt must, or may, be used to reduce certain losses that a taxpayer could bring forward from previous years. These losses include non-capital losses, farm losses, capital losses, capital; cost amounts, the undepreciated cost of depreciable properties, and the adjusted cost base amount of capital amounts (“tax attributes”). Paragraph 80(1)(c) of the ITA specifies a particular priority ordering for the forgiven debt to reduce these tax attributes.

Subsection 111(8) of the ITA defines a non-capital loss for a particular year to include unused losses from an office, employment, business or property. A capital cost allowance could be a component of this loss. Where this is the case, the courts have held that neither an undischarged bankrupt taxpayer, nor an absolutely discharged taxpayer, can carry forward such losses, and apply them in any post-bankruptcy year to reduce the income for that year.

Keeping that in mind, paragraph 128(2)(f) of the ITA states that an undischarged bankrupt cannot claim a non-capital loss in a post bankruptcy year to reduce the income for that year. In this regard, see Abtan v. R. [2006] 1 C.T.C. 2001 (T.C.C.); Delisle v. R. 2006 D.T.C. 3002 (T.C.C.); Smith v. R. [2003] 4 C.T.C. 2819 (T.C.C.); and Painter v. R. [2004] 2 C.T.C. 2100 (T.C.C.). Similarly, paragraph 128(2)(g) of the ITA provides that a taxpayer who is absolutely discharged from bankruptcy cannot claim such a loss in a post-bankruptcy year to reduce the income for that year. In this respect, see Canada v. Pottle [2005] 1 C.T.C. 421 (N.L. Prov. Ct) and Abtan v. R. [2006] 1 C.T.C. 2001 (T.C.C.).

It would appear that paragraphs 128(2)(f) and (g) of the ITA and the resulting jurisprudence operate on the premise that all of a bankrupt’s property vests in a trustee. However, as stated above, by virtue of paragraph 67(1)(c) of the BIA, property exempt from execution and/or subject to a security interest does not so vest. That is to say, a person, while bankrupt, can retain some of his or her property. When this is the case, the CRA will allow that person to claim an allowance for capital cost on such property, and if at the cessation of the business a terminal loss is the result, the amount of that loss may be so claimed.

Bob Skulski
Insolvency and Administrative Law Section
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch