14 June 1994 Internal T.I. 9322287 - MORTGAGE FORECLOSURE

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.

		June 14, 1994

	Saskatoon District Office	Head Office
L. E. Delorme	Rulings Directorate
	Assistant Director, Audit	B.Kerr
(613) 957-8953
	Attention:  F. Metanchuk	

		932228

Mortgage Foreclosure - Farm Property

This is in response to your memorandum of August 6, 1993, wherein you have asked us additional questions concerning the application of sections 79 and 80 of the Income Tax Act as a result of our response to you in file # 931082 on July 6, 1993. We apologize for the delay in responding.

Unless otherwise stated all references to statute are references to the Income Tax Act S.C. 1970-71-72, c.63 as amended consolidated to June 10, 1993 (the "Act").

It is your understanding that section 79 applies when a mortgagee or similar creditor acquires or reacquires beneficial ownership of a property in consequences of the failure of a mortgagor or other debtor to pay all or any part of an amount owed to the creditor. Acquisition of property may take place by means of court ordered foreclosure, a repossession under a conditional sales agreement or a quit claim.

You have indicated that it is your understanding that a quit claim deed conveys only such interest as the grantor has in the land but conveys no warranties or promises. In Saskatchewan, a quit claim has very little use as it cannot be registered at the land titles office. In your particular situation, the quit claim signed by the farmer in consequence of the "Consideration Agreement", facilitated the agreement and not any foreclosure action. If the farmer failed to abide by the warranties and covenants as stated in the agreement, the bank would have declared the agreement null and void and continued its foreclosure action. Under Saskatchewan law, the conveyance of the land to the bank would have extinguished the debt. This is not what has happened in your case. The nature of the transaction was one where property was transferred to the bank for consideration.

From our review of the Consideration Agreement, we note the following at page 2:

XXXXXXXXXX

We also note some of the following relevant provisions:

XXXXXXXXXX

XXXXXXXXXX

Our Comments

The application of section 79 or 80 of the Act would depend on a complete review of all facts of each particular case. As pointed out in your understanding of section 79, inter alia, there are two main conditions that must first be present. Consequently, two facts must first be determined: the first, is whether there has been an acquisition or reacquisition of the beneficial ownership of property by a mortgagee or other creditor of another person; and the second, being the reason for the acquisition or reacquisition. If there has been an acquisition or reacquisition and the reason for such was this other person's failure to pay all or any part of an amount owing by them to the mortgagee or creditor, the provisions of section 79 of the Act would apply.

Your specific questions and our responses are as follows:

(a)Does this mean that in all cases where farm land is transferred to a creditor in consequences of the failure of the farmer to pay all or part of the amount owed to the creditor, section 79 applies and therefore section 80 does not?

-Yes. The conditions for the application of section 79 of the Act, include the acquisition or reacquisition of property by a mortgagee or other creditor of another person and that this acquisition or reacquisition is in consequence of the other person's failure to pay all or any part of an amount owing to the mortgagor or creditor. Since both of these conditions are met the provisions of section 79 would apply. Therefore, by virtue of paragraph 80(1)(e) of the Act, the provisions of subsection 80(1) of the Act would not apply.

You then extended the question as follows:

(i) even if there was no court order foreclosure?

(ii) even if there was no court ordered foreclosure but foreclosure action was started but not proceeded with?

(iii) even if a true quit claim was not signed by the farmer. You state that a true quit claim is one which the farmer signed and just walked away.

-Our response is the same as in (a) above, however we would note that the methods of acquisition or reacquisition as listed in paragraph 2 of Interpretation Bulletin IT-505 are for the purpose of determining whether there has been an acquisition or reacquisition. They are not used for the purpose of determining the reason for the acquisition or reacquisition.

You also asked:

(v) can not an argument be made that a debt was settled, by way of a mutual agreement, otherwise than by payment in full of the principal amount, whereby, the word "payment" could include payment in kind? If so section 80 could apply.

-It would seem that an argument can be made that the acquisition was in consequence of the debtor's failure to pay due to the acknowledgment by him of the "default". On the other hand, it could also be argued that the acquisition took place as part of a negotiated settlement based on the remaining provisions of the agreement since there is an intention to pay the indebtedness; the transfer of the land is considered to be a part payment and there are also subsequent repayments. Nevertheless foreclosure proceedings initiated this.

The stronger argument in our opinion would be the former. Even though the formal foreclosure proceedings were not carried out, in our view, it does appear that the acquisition of the land by the creditor (XXXXXXXXXX) was done as a consequence of the failure to pay all or any part of an amount owing. As a result, the provisions of section 79 of the Act would apply. The debtor's proceeds of disposition under paragraph 79(c) would be the principal amount of the taxpayer's claim plus all amounts each of which is the principal amount of any debt that had been owing by the other person, to the extent that it has been extinguished by virtue of the acquisition.

In your case,

XXXXXXXXXX

We would also refer you to our response to question 53 at the 1993 Revenue Canada Round Table held at the 1993 Canadian Tax Foundation Conference, which dealt with the application of section 79 of the Act to a situation dealing with the acquisition of property by a creditor as a consequence of a debtor's failure to pay a debt where the property is tranferred to the creditor in settlement of a debt.

You have also quoted the following statement that we made in our July 6, 1993 response concerning the Farm Credit Corporation transaction: "it would be unreasonable not to treat the taxpayer's loss as a non-deductible capital loss", and you have asked if the taxpayer received no consideration as a result of the guarantee, would we not have to deny the capital loss pursuant to subparagraph 40(2)(g)(ii)?

-Our statement was made in conjunction with a statement we made that "if the guarantee has been given for adequate consideration, it will generally be considered to have been given for the purpose of gaining or producing income." The courts have on numerous occasions concluded that the providing of a guarantee constitutes a service and hence a business. Any business loss that is not utilized in the year it is incurred would in fact be included in the determination of a taxpayer's non-capital loss in accordance with the provisions of paragraph 111(8)(b). However, since this is not the case in the circumstances you describe, we would agree that any capital loss that would result from the disposition of the debt that arose as a result of the guarantor having to make good on the guarantee would be disallowed under subparagraph 40(2)(g)(ii) as it was not incurred for the purpose of gaining or producing income from a business or property.

In regards to this transaction you have also commented that for the purpose of section 79, the fair market value of the land should not be a factor as the proceeds of disposition are considered to be the principal amount of the debt and that no interest expense should be allowed since none was paid.

-We agree that for the purposes of section 79, the fair market value of the land is not relevant in determining its proceeds of disposition. However, at the time the land is taken its fair market value exceeds the principal amount of the taxpayer's claim and it is our view that this excess would be considered to be interest paid at that time and therefore deductible in computing income from business.

We understand that you have several outstanding files involving similar situations and that with the advent of the Farm Review Board in Saskatchewan, farmers and creditors usually come to some sort of negotiated settlement rather than the creditors proceeding with foreclosure action. In most cases this involves a transfer of land to the creditor and as part of the negotiated settlement the farmer signs a quit claim. Subject to your determination and review of all the particular facts of each individual case, our comments as outlined above as well as those outlined in IT-505 would also apply.

R. Albert
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch