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: Whether section 79, specifically, subsections 79(2) and (3) apply to the series of transaction and if so whether:
1) there is a capital gain on the deemed disposition,
2) there is a creation of a capital dividend account from the non-taxable portion of the gain, and
3) there is a non-capital loss carry forward balance from the accrued interest
Position: General comments provided.
Reasons: Depends on the facts of the case.
XXXXXXXXXX 2009-030575
V. Srikanth
May 27, 2009
Dear XXXXXXXXXX :
Re: Surrender of Property
This is in response to your letter dated January 5, 2009 wherein you requested our views on the tax consequences from the surrender of a capital property.
The relevant facts can generally be summarized as follows:
1. In Year 1, a Canadian-controlled private corporation, the debtor, borrows an amount from an arm's length third party, the creditor, at an interest rate of 10% per annum.
2. The debtor uses these funds to construct and operate a hotel, which represents a capital property to the debtor.
3. During Year 1 and Year 2, the debtor fails to repay any portion of either the principal amount or the interest thereon. However, it claims a deduction for the interest amount pursuant to paragraph 20(1)(c) of the Income Tax Act (the "Act").
4. During the two years, the debtor has only interest expense and no revenue. It therefore reports a non-capital loss to the extent of the interest expense, which amount accumulates over the period of 2 years.
5. At the start of the Year 3, the creditor forecloses on the hotel. Under the foreclosure agreement, the debtor voluntarily surrenders the property, i.e., the hotel, and all amounts owing to the creditor are extinguished.
You are of the view that section 79 of the Act, and more specifically subsection 79(2) of the Act applies with respect to the transfer of the property to the creditor by the debtor. You would like us to comment on your following views of the tax consequences of the above transactions:
- Section 79(3) of the Act applies to the above transaction resulting in a capital gain on the surrender of the property by the debtor.
- The debtor has a non-capital loss carry forward balance from the interest expense claimed and this can be used to offset the taxable capital gain.
- The debtor is also eligible for a capital dividend account ("CDA") pursuant to subsection 89(1) of the Act, which amount is equal to the non-taxable portion of the capital gain.
Our Comments
The facts in your letter appear to relate to a factual situation involving specific taxpayers. Please note that written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject of an advance income tax ruling request submitted in a manner set out in Information Circular 70-6R5. As stated in paragraph 22 of Information Circular 70-6R5, written opinions are not advance tax rulings and, accordingly, are not binding on the Canada Revenue Agency. Therefore, although we are not able to comment directly on the facts submitted with your correspondence, we would offer the following general comments regarding the tax consequences to a debtor on the surrender of property.
The provisions of section 79 of the Act apply in the event that property is surrendered by a debtor to a creditor. Subsection 79(2) of the Act sets out the circumstances in which property is considered to be "surrendered" by a person to another person as follows:
"where the beneficial ownership of the property is acquired or reacquired at that time from the person by the other person and the acquisition or reacquisition of the property was in consequence of the person's failure to pay all or part of one or more specified amounts of debts owed by the person to the other person immediately before that time."
Subsection 79(3) of the Act establishes the rules to determine the deemed proceeds of disposition to a debtor where, in fact, a particular property is surrendered at any time by a debtor to a creditor and in consequence of the debtor's failure to pay all or part of one or more 'specified amounts' of debts owned by the debtor. Subsection 79(1) defines 'specified amount' to include both the unpaid principal amount and the accrued interest on that debt at the time of the surrender of the property.
When a debtor has defaulted on a loan and interest repayments to its creditor, and the creditor has therefore foreclosed on the property towards which the loan and interest amounts were outstanding, and reacquired the property, the provisions of subsections 79(2) and 79(3) of the Act would apply. However, if there is an indication that the foreclosure arrangement was part of an agreement or was in anticipation of, rather than in consequence of the debtor's failure to pay, then section 79 may not apply; instead section 80 may come into play.
As explained above, on the surrender of a property to which subsection 79(3) would apply, an amount would be deemed in respect of proceeds of disposition in accordance with the formula therein. The amount so deemed would be used to calculate the debtor's gain, capital gain and taxable capital gain in accordance with paragraphs 40(1)(a), 39(1)(a) and 38(a), respectively. It should be noted that, in section 54, the definition of "proceeds of disposition" for purposes of subdivision c and, specifically, the determination of a taxpayer's gain pursuant to paragraph 40(1)(a), includes, among other things, "any amount included in computing a taxpayer's proceeds of disposition of the property because of section 79".
Generally, a capital gain arising on the application of the foregoing provisions would result in the creation of a CDA balance in accordance with the definition in paragraph 89(1)(a) of the Act.
Where, in fact, a debtor had a non-capital loss carry-forward from interest expenses arising during the period it held a property, generally, this non-capital loss could be used to offset the taxable capital gain that arose as a result of the surrender of that property and the application of section 79 of the Act.
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
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2009
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2009