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: Can a 50(1) election trigger debt forgiveness?
Position: A subsection 50(1) election may satisfy some of debt parking requirements in subsection 80.01(7).
Reasons: Application of the law.
XXXXXXXXXX
2014-052495
August 8, 2014
Dear XXXXXXXXXX:
Re: Debt Forgiveness
This is in response to your email of March 19, 2014 concerning debt forgiveness and the winding-up of an insolvent corporation.
An individual (the "Individual") resident in Canada is the sole shareholder of a taxable Canadian corporation ("Canco") that is a Canadian-controlled private corporation. The individual does not deal at arm's length with Canco. The Individual loaned an aggregate of $XXXXXXXXXX (the "Loan") to Canco over a period of years on a non-interest bearing basis.
Canco has ceased to carry on any material activity and is insolvent. It has non-capital loss carryforwards of $XXXXXXXXXX. Canco does not have any other loss carryforwards, undepreciated capital cost, property or cash. In XXXXXXXXXX, it did not have any taxable income or any material prospects for income in the future. The Loan is currently the only material liability of Canco. The Individual wishes to dissolve Canco and is considering making an election under subsection 50(1) of the Income Tax Act (the "Act").
You have asked for our comments relating to the settlement of the Loan and the winding-up of Canco. In particular, you are asking about the application of the debt parking rules in section 80.01. You also ask whether an insolvent corporation can be dissolved.
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 matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Also, where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Nonetheless, we have provided some general comments below.
Settlement of the Loan
Generally, the debt forgiveness rules apply only when there has been a settlement of an obligation. Paragraph 80(2)(a) of the Act provides that "an obligation issued by a debtor is settled at any time where the obligation is settled or extinguished at that time." The Tax Court of Canada in Carma Developers Ltd. v. The Queen, [1996] 3 C.T.C. 2029 (T.C.C.), affirmed at [1997] 2 C.T.C. 150 (F.C.A.), stated:
In the context of section 80, however, "settle" connotes a final and legal resolution of a taxpayer's obligation whereby that obligation is reduced or brought to an end
. Moreover, it must be a final and legally binding termination or reduction of the debtor's obligations.
The court case of The Queen v. Diversified Holdings Ltd., [1997] 2 C.T.C. 263 (F.C.A.) (leave to appeal to S.C.C. denied) also dealt similarly with this issue.
Further, the "debt parking" rules in section 80.01 of the Act may apply to deem the Loan to have been settled. Generally, subsection 80.01(8) of the Act provides for a deemed settlement of a "commercial debt obligation" issued by a "debtor" where the obligation becomes a "parked obligation" and the "specified cost" at the particular time to the holder of the obligation is less than 80% of the principal amount of the obligation. Under paragraph 80.01(7)(a) of the Act, generally, an obligation becomes a "parked obligation" if certain conditions are met such as the obligation is a "specified obligation" and the holder of the obligation does not deal at arm's length with the debtor. Under subsection 80.01(6) of the Act, an obligation is a "specified obligation" if the obligation is deemed by subsection 50(1) of the Act to have been reacquired at a particular time.
If a valid subsection 50(1) election is made, the debt parking rules will deem the Loan to be settled because all the requirements of subsection 80.01(8) are met. In this regard, the Loan has become a parked obligation and the specified cost at the particular time to the holder of the obligation (which would be nil as a result of the subsection 50(1) election) will be less than 80% of the principal amount of the obligation.
If an election is not made under subsection 50(1) of the Act, the Individual cannot claim a capital loss in respect of the Loan unless the Individual has disposed of the Loan. Generally, unless the Individual has assigned the Loan to a third party, the Individual will not be able to dispose of the Loan without a corresponding settlement of the Loan for purposes of the debt forgiveness rules. Even if the Individual does dispose of the Loan, the stop-loss rules (e.g. subparagraph 40(2)(g)(ii)) in the Act may apply to deny a capital loss in the hands of the Individual.
If the Loan is settled and an amount is included in Canco's income under subsection 80(13) of the Act because of debt forgiveness, a full or partial offsetting deduction under subsection 61.3(1) of the Act may be available to the Individual. Generally, where the debtor is a corporation resident in Canada, the amount of the deduction is calculated under a formula set out in subsection 61.3 (1) of the Act that takes into account elements such as the debtor's assets and distributions made to shareholders.
If the Loan is settled, assuming that the amount for which the Loan was issued is equal to the principal amount of the Loan, the "forgiven amount" would be zero. In addition, no income inclusion for Canco would arise from the debt forgiveness if Canco is "bankrupt" at the time of the settlement as a result of paragraph (i) of the definition of "forgiven amount" in subsection 80(1) of the Act. "Bankrupt" is defined in subsection 248(1) of the Act as having the meaning assigned by the Bankruptcy and Insolvency Act (Canada) (the "BIA"). Section 2 of the BIA defines a "bankrupt" as being "a person who has made an assignment or against whom a bankruptcy order has been made or the legal status of that person".
Winding-up of Canco
Whether an insolvent corporation can be dissolved is a matter for the governing corporate law. The 2013 T2 Guide (Form T4012) notes that if a person wishes to dissolve a corporation, that person should send an application for dissolution to the government body that governs the affairs of that corporation.
We trust that these comments will be of assistance.
Yours truly,
G. Moore
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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