26 January 2010 Internal T.I. 2009-0340241I7 - Computing Taxable Income of a Bankrupt Corporation

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 a bankrupt corporation could deduct section 111 losses and the investment tax credit under s. 127(5).

Position: Yes, but only while it remains bankrupt.

Reasons: Paragraph 128(1)(g) provides that, as long as it remains bankrupt, a corporation may claim section 111 losses. Section 128 does not provide any impediment to the corporation claiming the investment tax credit under s. 127(5).

									January 26, 2010

Eastern Quebec Tax Services Office				HEADQUARTERS
Rimouski								Lindsay Frank
(613) 948-2227
Attention: Marcel Cormier, Director
									2009-034024

Computing Taxable Income of a Bankrupt Taxpayer

This is reply to an email from Diane Brunet. At issue is whether a bankrupt corporation, in computing its taxable income for a post-bankruptcy year, could deduct losses under section 111, and the investment tax credit under subsection 127(5) of the Income Tax Act (the "Act") from the pre-bankruptcy period.

In accordance with section 111 of the Act, a taxpayer may use losses when calculating taxable income in a taxation year. Most of the losses may be carried back three years, or carried forward twenty years. Pursuant to subsection 127(5) of the Act, a taxpayer may deduct from the tax otherwise payable by the taxpayer for a taxation year the amount of the investment tax credit on certain qualifying expenditures of a taxpayer. Unused credits may be carried back three years or carried forward twenty years.

Pursuant to section 71 of the Bankruptcy and Insolvency Act ("BIA"), on the day of bankruptcy the property of the bankrupt vests immediately in the trustee, at which time the bankrupt is no longer able to dispose of, or otherwise deal with, the property. The trustee is then generally required to liquidate that property for the benefit of the creditors of the estate. The liquidation may give rise to the corporation having to report income that may have arisen.

Subsection 128(1) of the Act contains rules regarding the taxation of a bankrupt corporation. By paragraph 128(1)(a) of the Act, the trustee is deemed to be the bankrupt corporation's agent for all tax purposes. Accordingly, the trustee is required to perform tasks that the corporation ordinarily would be required to do under the Act. One such task is to file tax returns, in accordance with subsection 150(3). In this regard, paragraph 128(1)(d) of the Act deems the corporation's taxation year to end on the day immediately prior to the date of the bankruptcy, and deems a new taxation year to have started on the date of the bankruptcy.

Despite section 71 of the BIA, however, paragraph 128(1)(c) provides that any income generated by the trustee from the liquidation of the corporation's property is deemed to be the corporation's income. Nonetheless, in accordance with paragraph 128(1)(e), during the period of bankruptcy, the bankrupt corporation and the trustee are jointly and severally liable to pay the corporation's tax payable. But the trustee's liability is limited to the property in his possession, pursuant to paragraph 128(1)(e).

The relevant rule, when computing taxable income of a bankrupt corporation, is found in paragraph 128(1)(g), which provides:

"[W]here an absolute order of discharge is granted in respect of the corporation, for the purposes of section 111 any loss of the corporation for any taxation year preceding the year in which the order of discharge was granted is not deductible by the corporation in computing its taxable income for the taxation year of the corporation in which the order was granted or any subsequent year."

Accordingly, as long as the corporation remains bankrupt, the trustee could deduct section 111 losses incurred before and during bankruptcy, when computing taxable income. However, should the corporation emerge from bankruptcy, by obtaining an absolute discharge from bankruptcy, it cannot deduct section 111 losses incurred before and during bankruptcy. With respect to the investment tax credit, section 128 does not provide any impediment to the corporation making such a deduction during bankruptcy or after being absolutely discharged from bankruptcy.

It should be noted that a bankrupt corporation does not ordinarily obtain an absolute discharge from bankruptcy. Almost all corporations cease to carry on a business having declared or having been put into bankruptcy. However, a corporation may obtain a discharge from bankruptcy by paying its debts in full to the creditors, see subsection 169(4) of the BIA.

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
Legislative Policy and Regulatory Affairs Branch

c.c. Diane Brunet

Audit Section
Eastern Quebec Tax Services Office/Rimouski