5 April 1994 External T.I. 9334885 - DEBTOR'S GAIN ON SETTLEMENT 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.

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.

Principal Issues:

Can a gain on settlement of debt reduce non-capital loss balance where the continued deductibility of that loss becomes unlikely but is still possible.

Position TAKEN:

As long as the losses are still deductible 80(1) willl not apply to require them to be reduced by the settlement of debt gain.

Reasons FOR POSITION TAKEN:

Wording of 80(1) does not provide flexibility to apply subjective judgement as to probabilties or "reasonable expectations" of same business income in a future year, as described in 111(5)

XXXXXXXXXX J.A. Szeszycki

Attention: XXXXXXXXXX

April 5, 1994

Dear Sirs:

Re: Debtor's Gain on Settlement of Debts

This is in reply to your letter of November 19, 1993 requesting our views on the interaction of subsections 80(1) and 111(5) of the Income Tax Act (the "Act"). Unless otherwise stated, all statute references are to the Income Tax Act 1970-71-72, c.63 as amended, consolidated to June 10, 1993. We regret the delay encountered in providing a response.

Where at any time in a taxation year a debt has been settled, paragraph 80(1)(a) of the Act provides that the settlement amount, as determined applying the words set out in the preamble, shall be applied to reduce certain outstanding loss balances, in the order listed within that paragraph. Specifically, the list includes, in order, non-capital losses, farm losses, net capital losses and restricted farm losses. These losses are reduced only to the extent that they themselves remain deductible against taxable income for the taxation year or a subsequent taxation year.

Subsection 111(5) of the Act provides that, in circumstances where control of a corporation has been acquired, that corporation's existing balance of non-capital losses will generally only be deductible to the extent that the "business" in which the losses were incurred is carried on with an expectation of profit and it can be considered as the same or similar business.

The problem arises in the year in which the debt is settled to which subsection 80(1) of the Act applies. In order to determine whether the existing balance of non-capital losses must be reduced, the question as to the deductibility of those losses in future years must first be answered. In the case of the acquisition of control of a corporation carrying on an ongoing business enterprise, it is impossible, as you point out, to establish with 100% certainty that the same or similar business income will be generated within the lengthy period of deductibility of those losses. Yet, there are no words used in the provision to qualify the deductibility of those losses such that a less than 100% certainty would be required.

It is our view that, as long as the possibility remains that the non-capital losses could be deducted against future business income, subsection 80(1) of the Act would be applicable. This position would not be altered if no same or similar business income were generated in the settlement year itself.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch