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 the stay of proceedings bars the CRA from adjusting XXXXXXXXXX 's tax returns for the periods prior to the filing under the CCAA.
2. Whether the CRA can disallow the losses reported by XXXXXXXXXX in the 2003 and 2004 taxation years.
3. Whether the proposed reassessment of the 2005 taxation year must be prorated between the pre-filing period and the post-filing period.
4. Whether XXXXXXXXXX can deduct interest expense on inter company loans and advances owing at the date of the filing under the CCAA.
5. Whether unused tax losses, declared in the Chapter 11 Proceedings as an asset of the bankrupt estate, can be disallowed in Canada in a proceeding under the CCAA.
Position: 1. No.
2. Yes.
3. There is no proration.
4. No, unless ordered by the Court.
5. Yes.
Reasons: 1. The stay of proceedings is only effective against the Crown if the Crown is a creditor.
2. The losses can be disallowed as they do not result in the Crown having a provable claim against XXXXXXXXXX .
3. The Income Tax Act splits a taxation year where the taxpayer is bankrupt; it does not split the taxation year where the taxpayer is insolvent.
4. Unless ordered by the Court, an insolvent person is not legally obliged to pay pre-filing amounts after the imposition of the stay of proceedings.
5. Local law applies, notwithstanding permission granted to continue an international insolvency in Canada.
October 15, 2009
XXXXXXXXXX Tax Services Office HEADQUARTERS
Audit Division Lindsay Frank
Attention: XXXXXXXXXX (613) 948-222
Large File Case Manager
2009-031464
Tax Considerations in an International Insolvency
This is in reply to an email from XXXXXXXXXX concerning tax matters related to the insolvency of XXXXXXXXXX
On XXXXXXXXXX filed a petition for relief, pursuant to Chapter 11 of the United States Bankruptcy Code ("Chapter 11 Proceedings"). On XXXXXXXXXX , it obtained an order under section 18.6 of the Companies' Creditors Arrangement Act ("CCAA"), in which, among other matters, the Ontario Superior Court of Justice recognised the Chapter 11 Proceedings as a "foreign proceeding" for the purposes of section 18.6 of the CCAA. The Court also imposed a stay of proceedings on remedies taken or that might be taken in respect of XXXXXXXXXX or any of its property. Further, it recognised in their entirety the orders made in the U.S. proceedings, and stated that the orders shall have effect throughout Canada, as if they were orders of the Court made in proceedings under the CCAA. As well, it declared that XXXXXXXXXX was entitled to relief under section 18.6 of the CCAA.
In the 2003, 2004, and 2005 taxation years, XXXXXXXXXX reported losses which were carried forward to subsequent years. As of XXXXXXXXXX was no longer insolvent. XXXXXXXXXX has since been informed that the Canada Revenue Agency ("CRA") intends to disallow the losses or a portion thereof claimed in 2003, and that the proposed disallowance would not result in any tax payable.
Issue #1
Whether the stay of proceedings bars the CRA from adjusting XXXXXXXXXX 's tax returns to the period prior to the filing under the CCAA.
Answer
The stay of proceedings does not impede the CRA from adjusting XXXXXXXXXX 's tax returns for the period prior to the filing under the CCAA because the Crown is not a creditor.
Analysis
The CCAA permits an insolvent company to conclude an arrangement to settle its debts with its creditors. While negotiating such a settlement, section 11 of the CCAA imposes a stay of proceedings on creditors. For the CCAA to apply to a person, the person must, in general, be a creditor. For a person to be a creditor, that person must have a claim against the company, pursuant to section 12.
Subsection 12(1) and subparagraph 12(2)(a)(ii) are the provisions that are relevant to this case. Subsection 12(1) reads:
"For the purposes of this Act, 'claim' means any indebtedness, liability or obligation of any kind that, if unsecured, would be a debt provable in bankruptcy within the meaning of the Bankruptcy and Insolvency Act."
Algoma Steel Corp. v. Royal Bank (1992), 11 C.B.R. (3d) (Ont. Gen. Div.) holds that subsection 12(1) defines a "claim" to mean "any indebtedness, liability or obligation" determinable by reference to whether a claim is a debt provable in bankruptcy under the BIA.
Subparagraph 12(2)(a)(iii) reads:
"For the purposes of this Act, the amount represented by a claim of any secured or unsecured creditor shall be determined as follows: (a) the amount of an unsecured claim shall be the amount ... (iii) in the case of any other company, proof of which might be made under the Bankruptcy and Insolvency Act ["BIA"], but if the amount so provable is not admitted by the company, the amount shall be determined by the court on summary application by the company or by the creditor; ..."
In other words, any determination of a claim under the CCAA must be carried out in accordance with the relevant provisions of the BIA, see Re Alternative Fuel Systems (2004), 47 C.B.R. (4th) 1 (Alta. C.A.).
For a claim to be provable in bankruptcy, subsection 121(1) of the BIA must apply. It provides that the claim must be a debt or liability arising from an obligation incurred before the day on which the bankruptcy arose. Subsection 121(1) reads as follows:
"All debts and liabilities, present or future, to which the bankrupt is subject on the day on which the bankrupt becomes bankrupt or to which the bankrupt may be subject before the bankrupt's discharge by reason of any obligation incurred before the day on which the bankrupt becomes bankrupt shall be deemed to be claims provable in proceedings under this Act."
In XXXXXXXXXX 's case, no obligation arose when it reported a loss in its 2003 taxation year, and no liability or debt was created or was payable to the fisc. Accordingly, the Crown did not have a provable claim within the meaning of section 121 of the BIA, and therefore, the stay of proceedings does not apply. Moreover, the Agency's proposal to disallow the losses reported in 2003 does not create a current obligation on XXXXXXXXXX 's part. There is no debt, present or future, in respect of the tax losses either at the time of filing the arrangement or prior to the termination of the proceeding.
Since the proposed determination of the losses does not create a tax liability, it does not preclude the CRA from disallowing the losses. Furthermore, Renaud v. R., 2008 D.T.C. 4093 (T.C.C.), stands for the proposition that section 4.1 of the BIA applies only when the Crown is a creditor. It follows, then, that the stay of proceedings does not apply in this case.
Issue #2
Whether the CRA can disallow the losses reported in the 2003 and 2004 taxation years.
Answer
XXXXXXXXXX 's losses, reported in 2003 and 2004, can be disallowed; doing so does not make them a provable claim.
Analysis
Although section 111 of the ITA permits a taxpayer to carry forward losses reported in a particular taxation year to a subsequent year, in accordance with subsection 152(7) of the ITA the Minister is not obliged to accept the information reported by the taxpayer. Subsection 152(4) gives the CRA the authority to examine a particular return, and B & M Carriers Ltd. v. M.N.R.[1993] 2 C.T.C. 280 (T.C.C.) stands for the proposition that the Minister is not precluded from inquiring into the actual amount of non-capital losses available. The Minister is required to do so in order to assess in accordance with the provisions of the ITA as they relate to the computation of income. New St. James Ltd. v. M.N.R., [1966] C.T.C. 305 (Ex. Ct.) holds that the Minister is obliged to assess in accordance with subsection 152(4), which allows for the correction of an error in a year that is not statute-barred, even though it involves adjusting losses carried forward from previous years. Moreover, as explained in Issue #1 above the disallowance does not result in the Crown having a provable claim.
Issue #3
Whether the proposed reassessment of the 2005 taxation year is considered a total loss post CCAA, or whether it would have to be prorated between the pre-filing period and the post-filing period.
Answer
A taxpayer corporation filing under the CCAA has one taxation year; a filing under the CCAA does not mean that the corporation is bankrupt.
Analysis
Paragraph 150(1)(a) of the ITA requires a corporation to file a return of income within six months after the end of the year. An exception to this is found in paragraph 128(1)(d), which provides that a bankrupt company must file two returns of income in a taxation year. Marchessault v. R., [2008] 3 C.T.C. 319 (F.C.A.) stands for the proposition that the ITA recognises bankruptcies only. It follows that in a CCAA proceeding, a taxpayer cannot file two returns of income. Therefore, there is no requirement to prorate any adjustments to the 2005 taxation year.
Issue #4
Whether XXXXXXXXXX can deduct interest expense on amounts owing at the date of the filing under the CCAA.
Answer
Unless ordered by the Court, XXXXXXXXXX cannot deduct interest in the period following the filing under the CCAA on amounts owing in the pre-filing period.
Analysis
Whether XXXXXXXXXX can deduct interest expense on inter company loans and advances transacted before the filing of the CCAA proceeding depends on orders issued by the Ontario Superior Court of Justice, following XXXXXXXXXX 's filing under the CCAA. Reference is made to document E2008-030484, where the position taken was that paragraph 20(1)(c) of the ITA allows interest to be deducted where the taxpayer is legally obliged to pay it, unless the Court ordered XXXXXXXXXX to pay it. It was not possible to discern in any of the various Court orders that such a stipulation was made. Consequently, the position taken in document E2008-030484 stands.
Issue #5
Whether unused tax losses, declared in the Chapter 11 Proceedings as an asset of the bankrupt estate, can be disallowed in Canada in a proceeding under the CCAA.
Answer
Tax losses, declared as an asset in Chapter 11 proceedings, can be disallowed pursuant to the Income Tax Act ("ITA") because Canadian law applies.
Analysis
Section 18.6 of the CCAA contemplates that a foreign proceeding will be coordinated with a proceeding under the CCAA. The objective of coordinating proceedings is to ensure that creditors are treated as equitably and fairly as possible wherever they are located. In short, section 18.6 applies to creditors. In the XXXXXXXXXX proceedings, the Crown is not a creditor; therefore, section 18.6 does not apply where the CRA is proposing to disallow losses whereby no tax payable will be the result.
XXXXXXXXXX contends that the proposed disallowance of the losses would run afoul of U.S. bankruptcy law, which deems those losses to be an asset of the bankrupt estate. The position taken by XXXXXXXXXX that the filing under section 18.6 of the CCAA gave effect to the U.S. bankruptcy filing, particularly paragraphs 5 and 6 of the initial Court order of XXXXXXXXXX , is that claims against the property of the Chapter 11 bankruptcy will only be given on XXXXXXXXXX 's consent or by leave of the Court. XXXXXXXXXX expects the BIA or the CCAA would afford creditors similar protection, and takes the view that the Ontario Superior Court of Justice, in its initial order dated XXXXXXXXXX , supports that position. Three reasons justify the CRA's position to the contrary.
First, the order granted by the Court allowing XXXXXXXXXX to continue its insolvency in Canada does not constitute the abrogation of applicable Canadian law. As stated in Menegon v. Philip Services Corp. (1999), 11 C.B.R. (4th) 262 (Ont. S.C.J. [Commercial List]), "comity and international cooperation do not mean that a Canadian court must cede its authority over its own process or over the application of its own substantive laws, whenever any kind of differences between Canadian and foreign jurisdictions arise".
In this respect, while a Chapter 11 Proceeding is a bankruptcy proceeding, a filing under the CCAA does not declare XXXXXXXXXX to be bankrupt.
As stated in Re Alternative Fuel Systems Inc. (2004), 47 C.B.R. (4th) 1 (Alta. C.A.), "The objects of the BIA and the CCAA are distinct, and each must be interpreted with their respective purposes in mind". Further remarks in this judgment illustrate the distinction:
"The BIA is largely designed to facilitate the orderly liquidation of the estate of a bankrupt. The purposes of the Act include conducting the liquidation in a manner that maximises recovery for the general benefit of creditors ... The Act sets out priorities and a detailed process, making the BIA a logical choice when the only possible outcome is dissolution."
"The CCAA affords the debtor company an opportunity to restructure its affairs in a manner that will permit it to continue as a going concern without intervention by creditors which might hamper or prevent the restructuring process. Its ultimate goal is to avoid bankruptcy."
Second, under the International Financial Reporting Standards ("IFRS"), specifically International Accounting Standard ("IAS") 12, a deferred tax shall be recognised for the carry forward of unused tax losses, to the extent that it is probable that taxable profit will be available against which the unused tax losses can be utilised. The term "probable", although not defined in IAS 12, is taken to mean "more likely than not, consistent with the definition used elsewhere in the IFRS, see Charles Chaho, "Spotlight on Tax Losses", The Tax Advisor (July 2009) 23, at pp. 23 -24. The article also points out that entities should ensure that they have good documentation to support their analysis and conclusions reached. In this case, there is insufficient documentation to support XXXXXXXXXX 's claim to such losses.
Third, in an insolvency setting where taxation is at issue, the tax statute governs, see Re Norris, [1989] 2 C.T.C. 185 (Ont. C.A.). Accordingly, the CRA is not barred from examining XXXXXXXXXX 's returns of income, filed before or after the company's insolvency, to determine whether the information is consistent with the provisions of the statute. The Minister's mandate is to administer the ITA. A part of this mandate requires the review of previously assessed returns to determine whether amounts were reported correctly, and to reassess them where necessary, see Allcann Wood Suppliers Inc. v. Canada, [1994] 2 C.T.C. 2079 (T.C.C.); and Coastal Construction & Excavating Ltd. v. R., [1996] 3 C.T.C. 2845 (T.C.C.).
Should you need for clarification or additional information, please do not hesitate to contact Lindsay Frank at the number provided above.
B. J. Skulski
Manager
Insolvency and Administrative Law Section
Business and Partnerships Division
Income Tax Rulings Directorate
c.c. XXXXXXXXXX
Large File Case Auditor
Audit Division
XXXXXXXXXX Tax Services Office
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
Email this Content