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 the settlement of an obligation to pay on a guarantee is subject to the debt forgiveness rules in section 80.
Position: No.
Reasons: Not a commercial debt obligation.
April 9, 2014
XXXXXXXXXX TSO HEADQUARTERS
International Audit Income Tax Rulings
Attention: XXXXXXXXXX, Team Leader Directorate
Lara Friedlander
(416) 952-7343
2014-051923
Debt Forgiveness and Guarantees
This is in response to your email of January 24, 2014 regarding the potential application of the debt forgiveness rules in section 80 of the Act to the settlement of an obligation to pay under a guarantee.
Facts
1. XXXXXXXXXX ("Canco") is a taxable Canadian corporation as defined in subsections 89(1) and 248(1) of the Act.
2. XXXXXXXXXX ("Forco"), a XXXXXXXXXX corporation, was a wholly-owned subsidiary of Canco in XXXXXXXXXX. Between XXXXXXXXXX and XXXXXXXXXX Canco subscribed for approximately $XXXXXXXXXX of shares of Forco.
3. Forco borrowed $XXXXXXXXXX (the "Borrowing") on a secured basis from a syndicate of XXXXXXXXXX financial institutions (the "Syndicate") led by the XXXXXXXXXX (the "Syndicate Leader"). None of the proceeds of the Borrowing were given directly or indirectly to Canco. In connection with the Borrowing, Canco provided an unconditional guarantee (the "Loan Guarantee") secured by, inter alia, Canco's shares in Forco. Canco did not earn a fee for providing these guarantees.
4. Forco was also a party to several XXXXXXXXXX contracts (the "Contracts") with non-resident third parties (the "Third Parties"). Under the Contracts, the Third Parties provided XXXXXXXXXX services in XXXXXXXXXX to Forco for a fee. Canco guaranteed Forco's obligations (the "Contract Guarantees", together with the Loan Guarantee being the "Guarantees") in connection with these Contracts as well.
5. We assume that Canco's obligations under the Guarantees were not on income account to Canco.
6. In XXXXXXXXXX, Forco was insolvent and was put into a type of receivorship in XXXXXXXXXX by the Syndicate. In XXXXXXXXXX the Syndicate demanded payment from Canco under the Loan Guarantee of amounts owed by Forco under the Borrowing. At approximately the same time, the Third Parties demanded payment from Canco under the Contract Guarantees of fees owing by Forco under the Contracts. On XXXXXXXXXX Canco commenced proceedings under the Companies' Creditors Arrangement Act (Canada) (the "CCAA").
7. In XXXXXXXXXX the shares of Forco were sold. Approximately $XXXXXXXXXX of the proceeds were paid to the Syndicate and $XXXXXXXXXX of the proceeds were distributed to other creditors of Canco, including the Third Parties. At this point, the Syndicate was still owed $XXXXXXXXXX and the Third Parties were still owed $XXXXXXXXXX.
8. Canco defaulted on its obligations under the Guarantees.
9. In XXXXXXXXXX, an arm's length third party resident in Canada transferred a $XXXXXXXXXX royalty interest into Canco in return for shares of Canco representing a significant equity interest in Canco, but insufficient to trigger an acquisition of control of Canco.
10. We assume that at no relevant time was Forco an agent of Canco. We assume that at no relevant time were Canco and Forco in partnership.
Issue
Can section 80 be applied to Canco in respect of the amounts owed by Canco to the Syndicate under the Guarantees which were subsequently forgiven?
The debt forgiveness rules in subsection 80(3) to 80(13) of the Act apply in respect of a "forgiven amount" that arises when a "commercial obligation" of a "debtor" is "settled".
A "commercial obligation" of a debtor is defined in subsection 80(1) of the Act as "a commercial debt obligation issued by the debtor" or "a distress preferred share issued by the debtor".
A "commercial debt obligation" of a debtor is defined in subsection 80(1) of the Act as a debt obligation issued by the debtor where an amount in respect of the interest was or would have been deductible in computing the debtor's income, taxable income or taxable income earned in Canada if the Act were read without reference to particular provisions if interest was paid or payable by the debtor in respect of it pursuant to a legal obligation or if interest had been paid or payable by the debtor in respect of it pursuant to a legal obligation.
Is Canco's obligation a "commercial debt obligation"?
You have asked whether Canco's obligation to pay under the Guarantee would be a "commercial debt obligation" of Canco. Specifically, we considered whether any interest, if paid or payable on that amount, would have been deductible to Canco.
Assuming that Canco's obligations were on capital account, interest on those obligations would be potentially deductible only under subparagraph 20(1)(c)(i) or (ii) of the Act. Subparagraph 20(1)(c)(i) of the Act does not apply unless a taxpayer has borrowed money. In this case, we understand that none of the funds advanced under the Borrowing were advanced directly or indirectly to Canco; rather, all of the proceeds of the Borrowing were advanced to Forco. A number of authorities support the proposition that a taxpayer is a borrower only if there is an advance to that taxpayer and that taxpayer is obligated to return that advance to the lender. (See, for example, The Queen v. MerBan Capital Corporation Ltd., [1989] 2 C.T.C. 246 (F.C.A.), Wilson v. Minister of National Revenue, [1990] 2 C.T.C. 2325 (T.C.C.), A.C. Simmonds & Sons Ltd. v. Minister of National Revenue, [1990] 1 C.T.C. 2087 (T.C.C.), Rulings document 2000-0056297 dated March 21, 2001). In this case, although Canco has an obligation to repay the funds advanced, Canco was not the party to whom the funds were advanced initially. Accordingly Canco should not be considered to have borrowed money under the Borrowing. No funds were advanced to Forco or Canco under the Contracts.
Subparagraph 20(1)(c)(ii) of the Act applies to an amount payable for property acquired for the purpose of gaining or producing income from the property, so long as certain other conditions are met. In this case, the amounts owing by Canco were not amounts payable for property acquired for the purpose of gaining or producing income from property.
The conclusion that interest on the Guarantees would not be deductible to Canco is consistent with Rulings document 2011-0398721 (March 12, 2012). In this statement the CRA considered the situation where a court had ordered a guarantor to honour a guarantee and to pay interest on that amount. The CRA concluded that the interest on the amount owed under the guarantee was not deductible because the amount owed under the guarantee was not borrowed money for purposes of subparagraph 20(1)(c)(i) of the Act. See also Rulings document 59484 (February 26, 1990).
Accordingly, if interest had been paid or payable by Canco on its obligations, such interest would not have been deductible by Canco. Therefore Canco's obligations under the Guarantees were not "commercial debt obligations" as defined under subsection 80(1) of the Act.
For your information a copy of this memorandum may be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. Such a severed copy would also be distributed to the commercial tax publishers for inclusion in their databases. The severing process would remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they could be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Ms. Celine Charbonneau at (613) 952-1361. A copy would be sent to you for delivery to the client.
We trust that these comments will be of assistance.
G. Moore
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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