23 October 2012 External T.I. 2011-0429071E5 - Amalgamation of farming business

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 the amalgamation of Corp A and Corp B result in an income inclusion to Corp A in a situation where Corp A and Corp B each follow the cash basis of accounting, Corp B had issued a promissory note (the “Note”) to Corp A in consideration for a prior acquisition of inventory from a farming business, and the Note, or a portion thereof, was outstanding at the time of amalgamation?

Position: It is a question of fact.

Reasons: On amalgamation of Corp A and Corp B, pursuant to subsection 80.01(3) of the Act, Corp B would be deemed to have paid, and Corp A would be deemed to have received, an amount equal to Corp A’s cost amount of the Note. To the extent that Corp A’s cost amount of the Note is greater than zero, there could be an income inclusion pursuant to subparagraph 28(1)(a)(i) of the Act.

XXXXXXXXXX
2011-042907
V. Srikanth

October 23, 2012

Dear XXXXXXXXXX:

Re: Settlement of debt obligation on amalgamation

We are writing in response to your correspondence dated November 21, 2011, wherein you requested our view as to whether there would be an income inclusion to a creditor as a result of the application of subsection 80.01(3) of the Income Tax Act (the “Act”), in a particular scenario.

Specifically, you described a scenario wherein, a corporation carrying on a farming business (“Corp A”) sells its entire livestock inventory to another corporation (“Corp B”) in return for a promissory note (the “Note”). You indicated that because both Corp A and Corp B would be following the cash method of accounting, Corp A would include in income the amount from the sale of the inventory only when, and to the extent that, Corp B makes a payment against the Note. Similarly, Corp B would deduct its purchase of the livestock only at the time of such payments.

You further described that, at a time when an amount of the Note remains unpaid and outstanding, Corp A and Corp B would amalgamate. You requested our view as to whether the application of subsection 80.01(3) of the Act would result in Corp A having, immediately before the amalgamation, an income inclusion equal to the unpaid portion of the Note.

Our Comments

The particular circumstances in your request appear to represent a specific factual situation. As mentioned in paragraph 22 of Information Circular IC 70-6R5, entitled ‘Advance Income Tax Rulings’, dated May 17, 2002, it is not this Directorate's practice to comment on specific proposed transactions other than in the form of an advance income tax ruling. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. Your request was not submitted in the format required for an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries which are not binding, and we are prepared to provide you with the following comments.

Section 28 of the Act applies to taxpayers who elect to compute income from farming or fishing using the cash method. Pursuant to subparagraph 28(1)(a)(i) of the Act, a taxpayer is required to include in income all amounts that are received or deemed by the Act to have been received in the year. Paragraph 28(1)(e) allows as a deduction the total of all amounts (other than amounts described in section 30 of the Act, i.e., land improvement costs related to farming) that were paid in the year, or are deemed by the Act to have been paid in the year, in the course of carrying on the business.

Subsection 80.01(3) of the Act applies to amalgamations of debtors with their creditors and reads as follows:

“Where a commercial obligation or another obligation (in this subsection referred to as the "indebtedness") of a debtor that is a corporation to pay an amount to another corporation (in this subsection referred to as the "creditor") is settled on an amalgamation of the debtor and the creditor, the indebtedness shall be deemed to have been settled immediately before the time that is immediately before the amalgamation by a payment made by the debtor and received by the creditor of an amount equal to the amount that would have been the creditor's cost amount of the indebtedness at that time if:

(a) the definition "cost amount" in subsection 248(1) were read without reference to paragraph (e) of that definition; and

(b) that cost amount included amounts added in computing the creditor's income in respect of the portion of the indebtedness representing unpaid interest, to the extent those amounts have not been deducted in computing the creditor's income as bad debts in respect of that unpaid interest.”

Accordingly, in the scenario you described, Corp A would, pursuant to subparagraph 28(1)(a)(i) of the Act, be required to include in income its cost amount of the Note immediately before the amalgamation (i.e., the amount it was deemed by subsection 80.01(3) to have received), and Corp B would, pursuant to paragraph 28(1)(e) of the Act, be entitled to deduct Corp A’s cost amount of the Note immediately before the amalgamation (i.e., the amount it was deemed by subsection 80.01(3) to have paid).

The determination of a particular creditor’s cost amount for a particular indebtedness can only be determined following an examination of all the facts relevant to a particular situation. For example, in the scenario you described, Corp A’s cost amount of the Note immediately before the amalgamation, as determined by subsection 80.01(3) of the Act and paragraph 248(1) of the Act, could be impacted by whether subsection 76(1) of the Act applied to its sale of inventory to Corp B.

Subsection 76(1) of the Act applies where a taxpayer receives a security (for example, the Note in the scenario you described) as payment of, in lieu of payment of, or in satisfaction of, a debt then payable, and the amount of the debt would have been included in the taxpayer’s income if it were paid (for example, proceeds from the sale of inventory). Where this occurs, the value of the security is included in the taxpayer’s income in the taxation year in which the security is received. It is a question of fact whether a particular promissory note (for example, the Note in the scenario you described) is an absolute payment of a debt resulting in the application of subsection 76(1) of the Act or, rather, if it is a conditional payment (i.e., merely evidence of a debt) such that subsection 76(1) of the Act does not apply. Although it is usually considered that a creditor has accepted a promissory note as a conditional payment, in certain circumstances, a promissory note may be accepted as an absolute payment such that the debtor would be considered to have paid the debt. For instance, paragraph 8 of Interpretation Bulletin IT-77R states that a security will be considered to be received in absolute settlement of a debt if the creditor accepts the security at the risk of its being dishonoured with the only legal recourse being an action against the issuer for failure to honour the obligation (i.e., if payment of the promissory note could only be enforced under the terms of the promissory note).

If subsection 76(1) of the Act applied to the scenario you described (i.e., if Corp A accepted the Note as an absolute payment for the sale of inventory), in our view, pursuant to subparagraph 28(1)(a)(i) of the Act and subsection 76(1) of the Act, the amount of the Note received in respect of the livestock inventory should have been included in Corp A’s income for the year of the sale, and any amounts subsequently received by Corp A in respect of the Note would not be included in income. If, on the other hand, Corp A’s acceptance of the Note did not result in the application of subsection 76(1) of the Act, in our view, the Note would be a right to receive an amount and Corp A would include in income the amount from the sale of the inventory only when, and to the extent that, it receives, or is deemed by the Act to receive, a payment against the Note from Corp B.

With regards to Corp B, pursuant to the definition in subsection 80(1) of the Act, the forgiven amount, at any time, in respect of a commercial obligation is the amount determined by the formula "A - B" where:

• A is the lesser of the amount for which the obligation was issued or the principal amount of the obligation, and
• B is the total of the amount paid at that time in satisfaction of the principal amount of the obligation and, inter alia, such portion of the principal amount of the obligation which represents the principal amount of an ‘excluded obligation’.

Therefore, if a settled obligation is an excluded obligation, there would be no forgiven amount and, consequently, there would be no reduction of the tax attributes of, nor an income inclusion to, the debtor under the provisions of section 80 of the Act.

An ‘excluded obligation’, as defined in subsection 80(1) of the Act, includes, inter alia,

“…an obligation issued by a debtor where…

(b) an amount paid by the debtor in satisfaction of the entire principal amount of the obligation would be included in the amount determined under paragraph 28(1)(e) or section 30 in respect of the debtor…”

In the scenario you described, since Corp B would be entitled to include in the amount determined under paragraph 28(1)(e) of the Act an amount paid by it in satisfaction of the principal amount of the Note, in our view, the Note would be an excluded obligation. Accordingly, the settlement of the Note as a result of an amalgamation of Corp A and Corp B would not result in a forgiven amount within the meaning of that term as defined in subsection 80(1) of the Act. Consequently, regardless of Corp A’s cost amount of the Note, there would be no reduction of the tax attributes of, nor an income inclusion to, Corp B under the provisions of section 80 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