27 September 1990 External T.I. 900885 F - Promissory Note, Negotiable Instrument or Other Security Accepted by Bank Absolute or Conditional Payment of Debt

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.

Subject: 19(1)

This is in reply to your memorandum of May 23, 1990 concerning 24(1)

Our Comments

There is no "cut and dried" solution to your question, as it hinges largely on the question of whether a promissory note, negotiable instrument or other security has been accepted, for instance, by a bank as absolute payment or as a conditional payment of a debt. You may see a limited discussion of this matter in Interpretation Bulletin IT-436R which deals with the subject in relation to dispositions of property and reserves in respect of such dispositions.

In an article entitled "Income Tax Treatment of Financing" the writer states "It seems clear that the mere agreement by a lender to capitalize unpaid interest and add it to the principal sum will not constitute a deductible payment by the debtor or a taxable receipt by the lender.  In Stock Exchange Building Corporation v. MNR, 55 DTC 1014, the Supreme Court of Canada held that interest does not become capital merely because of the convenient designation of "capitalization".  No borrower-and-lender relationship exists with respect to the unpaid interest, and the interest debt will continue notwithstanding the capitalization." 

With respect to the specific a matter of refinancing debt and considering the interest paid another writer states in a publication entitled "Timing and Income Taxation" about cash basis accounting, "At common law, if a debtor gives a negotiable instrument to his creditor in performance of a contractual obligation, the creditor can accept it as collateral security for discharge of the obligation or as absolute satisfaction of the obligation.  There is a rebuttable presumption that the instrument is accepted only as conditional payment of the obligation.  If the instrument is accepted as absolute payment, the debtor will be considered to have paid the debt and the creditor will be considered to have received the value of the instrument (see IT-433). ....When an instrument is accepted as conditional payment, the debt is not discharged, but the creditor's remedy on the contract is suspended until the maturity of the instrument."  For a discussion of this principle see Royal Securities Corporation v. Montreal Trust (1967), 59 DLR (2d) 666, at 698 (Ont, HC). 

As you are probably aware, section 76 of the Act looks at this problem from the point of view of the creditor.  Under section 76, a creditor who receives a security or other evidence of indebtedness in satisfaction of an income debt will be required to include the value of the security in his income.  Unfortunately section 76 does not address the position of the debtor.

Paragraph 9(d) of IT 433 sets out the position that it may be possible to satisfy and therefore pay an obligation by delivery of a promissory note, or other negotiable instrument to a creditor. 

Although it is usually considered that the creditor has accepted an instrument as conditional payment or as evidence of indebtedness, in the appropriate circumstances the instrument may be accepted as absolute payment and the debtor will be considered to have paid the debt.  In IT-77R, for instance, it 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 his only legal recourse being an action against the issuer for failure to honour the obligation.

What all this means is  24(1)

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch