10 April 1992 Income Tax Severed Letter 9208575 - Forgiveness of debt — daylight loan

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

SUBJECT: FORGIVENESS OF DEBT - DAYLIGHT LOAN SECTION: 80(1)]

Section 80 - Forgiveness of Debt

QUESTION

IT-293R, Special Release, states in paragraph 2 that the provisions of section 80 are applicable when an amount owing to a shareholder by a corporation is extinguished by being contributed by the shareholder in the form of a capital contribution.

We have been made aware of situations where a Canadian corporation has extinguished an obligation on its balance sheet by means of circular transactions which avoids the application of section 80. The transaction works something like this:

• 1. Canco a wholly owned subsidiary of a US Parent Co., is financed by a loan from the parent of US$100 million.
• 2. Canco and Parent Co. are part of a multi-tiered multinational enterprise.
• 3. Grandparent Co., the parent of Parent Co., lends Canco US$100 million. On the same day, these funds are used to repay the US$100 million loan to Parent Co.
• 4. Parent Co., on the same day or a few days later, makes a capital contribution of US$100 million to Canco. Canco uses these funds to repay the loan from Grandparent Co.
• 5. It appears that Canco and Parent Co. avoided the provisions of section 80 by structuring the form of the transactions so that Parent Co. does not make a contribution to Canco to extinguish its own debt, but the debt of another member of the corporate group.

This is a set of transactions which I have only recently been made aware of. It may be that they can be attacked through GAAR. However, my concern is that the provisions of section 80 are highly dependent upon the form, rather than the substance, of the transaction entered into.

Any comments?

RESPONSE

Paragraph 2 of Special Release 293R states that the provisions of section 80 are applicable when an amount owing to a shareholder by a corporation is extinguished by being contributed by the shareholder in the form of a capital contribution. This paragraph goes on to state that this rule will also apply where these results are achieved through a series of transactions and gives the following example:

• "... where a corporation borrows money from a bank or lender on a daylight loan basis to pay the amount of a debt to its creditor and the creditor then uses the funds to buy shares in the corporation which in turn repays the daylight loan, section 80 will be applicable if the principal amount of the debt extinguished exceeds the fair market value of the shares acquired by the creditor."

If "Grandparent Co." is substituted for the words "bank or lender" above, the situation which you have described is identical to the one addressed in this special release. Hence, the Department's position is that section 80 would in fact apply in the circumstances you have described.

In situations not contemplated by IT293R [IT-293R], where a strict technical application of section 80 would not be possible, a section 80 assessment may be relying entirely on a "substance over form" argument. However, unlike the two main anti-avoidance doctrines dealing with ineffective transactions and sham transactions, the substance over form doctrine has not been applied frequently. The Supreme Court of Canada decision in Stubart (1984) [[1984] C.T.C. 294] formulated a series of guidelines that were intended to assist the courts in dealing with tax avoidance issues. In particular, the substance over form doctrine was omitted from the Stubart guidelines and thus was implicitly rejected by the Supreme Court as a judicial anti-avoidance test.

With the advent of GAAR, there would be no need to rely on a substance over form argument. Assuming transactions were undertaken primarily to obtain the tax benefit, they would be avoidance transactions designed to circumvent the application of section 80, and would therefore be subject to subsection 245(2).

L. Holloway
920857