15 July 2009 External T.I. 2008-0289731E5 - Forgiveness of Accrued Interest

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: Would section 80 apply where a creditor legally waives the right to receive accrued and payable interest (which interest was deductible in the computing of the income of the debtor) and forgives the amount in respect of such interest

Position: YES

Reasons: 80(2) (b) deems the interest payable as having a principal amount

XXXXXXXXXX 						V. Srikanth
							2008-028973
July 15, 2009

Dear XXXXXXXXXX :

Re: Section 80 - Waiver of Accrued Interest

This is in response to your letter dated August 7, 2008, wherein you requested a technical interpretation with respect to the potential application of section 80 of the Income Tax Act (the "Act") to a debtor in circumstances where a creditor legally waives the right to receive accrued and payable interest, which interest was deductible in the computing of the income of the debtor, and forgives the amount in respect of such interest.

More specifically, you wanted our views in respect of the following two hypothetical scenarios:

First, you wanted to know if section 80 would apply where such interest is waived and forgiven in the same taxation year in which it was accrued and became payable, or would such interest be included in the debtor's income for that year by virtue of section 9.

Second, you wanted to know if section 80 would apply where such interest is waived and forgiven in a taxation year subsequent to that in which it was accrued and became payable, or would such interest be included in the debtor's income for that year by virtue of section 9.

Our comments

The facts in your letter appear to relate to a factual situation involving specific taxpayers. As explained in Information Circular IC-70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. Furthermore, should your situation involve specific taxpayers and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. Nevertheless, we offer the following comments in connection with your request. These comments are of a general nature only. Any Canada Revenue Agency (the "CRA") publication referred to here may be obtained from the CRA website at www.cra.gc.ca.

Paragraph 80(2)(b) of the Act, provides that for the purposes of subsection 80(1), interest that had been deducted by the debtor in computing his income or that would have been deductible "but for subsection 18(2) or (3.1) or section 21", is deemed to be a principal amount equal to such interest. Paragraph 80(2)(b) of the Act is a deeming clause, and, in essence, it provides that for the purposes of subsections 80(1) and (3), an amount of interest in respect of a debt shall be deemed to be a debt issued by a taxpayer that has a principal amount. Therefore, subsections 80(1) and paragraph 80(2)(b) of the Act, read together, apply both to the principal amount of a debt in its ordinary sense and the amount of the debt that is made up exclusively of interest deducted or deductible by the debtor.

The debt forgiveness rules do not apply to the principal amount of an excluded obligation, which is defined in subsection 80(1) of the Act. An obligation is considered an excluded obligation if, inter alia, the principal amount of the obligation would, if it were settled without any payment, be included in the debtor's income in the absence of sections 79 and 80. In effect, section 80 will not apply in certain circumstances where the gain on the settled debt is of an income nature.

In this regard, the courts have held that the forgiveness of trade debts and similar obligations incurred in the course of carrying on a business are, in certain circumstances, included in the debtor's income under the general rules of profit computation under section 9 of the Act. The findings of the courts indicate that the determination depends on the purpose and effect of the forgiveness and the use of the debt proceeds. Where it is a trade debt or on account of income, it may be included in the taxpayer's computation of profit under section 9 of the Act. If the debt is considered on account of capital, section 80 of the Act may apply.

Further, in order to determine whether a forgiveness of a particular debt is on income or capital account, we refer to the Supreme Court's statement in the case of Oxford Motors Ltd v MNR [1959] CTC 195:

Whether a gain is to be classified as an income gain or capital gain, the determination of that question must depend in large measure upon the particular facts of the particular case.

In your letter, you have made reference to the following two court cases:

• British Mexican Petroleum Limited v. Jackson (1932), 16 T.C. 570, and
• Alco Dispensing Canada Ltd. v. The Queen, 97 DTC 5463

The Court's reasons in British Mexican Petroleum Limited v. Jackson (1932), 16 T.C. 570, which is the basis for the CRA's position on trade debts forgiven in a taxation year subsequent to that in which the debt was incurred, as described in paragraph 25 of the Interpretation Bulletin IT- 293R, Debtor's Gain on Settlement of Debt, involved the settlement of a trade account payable in a year subsequent to the year in which the debt was created. The Court stated that income is determined on a yearly basis and adjustments that arise from events in subsequent years affect the income of neither the original year nor the subsequent year. The House of Lords held that prior years could not be reopened and that the release from liability to repay did not give rise to income in the year of settlement. In this case, the Court:

• considered the debtor's gain on the settlement to be a gratuitous forgiveness in order to keep British Mexican Petroleum in business;
• concluded the debtor's gain on the settlement to be on account of capital; and
• found that as it was on account of capital it should not be included in income.

With respect to Alco Dispensing Canada Ltd. v. The Queen, 97 DTC 5463, the Federal Court of Appeal dismissed the taxpayer's appeal substantially. The following reasons were offered by Justice Bonner, who had rendered the decision on this case at the Tax Court level:

Furthermore I will observe that the assertion that the forgiveness of the bonus is a capital transaction is clearly illogical. If the creation of an enforceable obligation to pay bonus results in a cost which diminishes profit so also must the receipt of a waiver intended to boost profit by eradicating that same obligation result in an increase in profit.

In our view, any factual situations similar to those in Alco Dispensing, may, depending upon the timing of the transactions, be subject to the provisions of subsection 78(4) which deals with an amount in respect of a taxpayer's expense that is unpaid remuneration that includes salary and wages and is unpaid on the day that is 180 days after the end of the taxation year in which the expense was incurred.

Whether or not section 80 of the Act would be applicable to an interest amount that is waived and forgiven depends upon the facts of the case and also factors such as if the forgiven amount is on account of income or capital. Where the forgiven interest amount is determined to be on account of capital, section 80 of the Act is applicable, irrespective of whether or not the amount was forgiven in the same or subsequent taxation year.

Where the forgiven interest amount is determined to be on account of income, paragraph 25 of the Interpretation Bulletin IT-293R, states that:

Forgiveness of a trade debt in the same taxation year in which it was incurred is required to be included in computing the debtor's income for that year under the general rules for computing profit from a business or property. Where the debt forgiven is in respect of merchandise or other property in which the debtor deals, the cost of the property acquired is reduced by the amount of forgiveness whether or not it was sold in the year in which the debt was forgiven. Where the forgiveness occurs in a taxation year subsequent to that in which the debt was incurred, the same general rules of profit computation require that an amount be included in the profit computation for the year of forgiveness equal to that portion of the forgiven debt that relates to the inventory of merchandise on hand at the beginning of that year. In other circumstances under which a trade debt is forgiven, the rules described in 1 above apply (subject to any applicable exclusions described in 15 above).

The rules described in paragraph 1 of IT-293R, are those dealing with the application of section 80 of the Act.

Therefore, where the interest amount is determined to be on account of income, and the interest on the debt is forgiven in the same taxation year in which the interest expense is deducted or deductible, the interest amount is included in income in that same taxation year. Generally, where such amount is forgiven in a subsequent year, in our view, section 80 of the Act will apply.

We trust our comments will be of assistance to you.

Yours truly,
R. A. Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch