5 April 1995 External T.I. 9431435 - FORECLOSURE AND 116(5)

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: Would we apply subsection 116(5) where a creditor acquires taxable canadian property as a result of a non-resident person defaulting on its debt?

Position TAKEN: Yes

Reasons FOR POSITION TAKEN: Where the property is being sold (whether by court order or not) then there is a disposition to which subsection 116(5) would apply.

		943143
XXXXXXXXXX	M.P. Sarazin
(613) 957-2118

Attention: XXXXXXXXXX

April 6, 1995

Dear Sirs:

Re: Subsection 116(5) of the Income Tax Act (the "Act")

This is in reply to your letter dated November 18, 1994 wherein you requested our comments as to whether subsections 116(5) and (5.3) of the Act would apply where a creditor acquires taxable Canadian property as a result of a non-resident person defaulting on its debt.

Generally, a debtor (the "Mortgagor") may secure a debt obligation owing to a creditor (the "Mortgagee") by granting a pledge or mortgage of real property (the "Property"). If the Mortgagor defaults then, depending on the terms of the debt, the Mortgagee may seek one of the following remedies:

The Mortgagee may apply to the courts for an Order of Foreclosure whereby the Mortgagee acquires ownership of the Property and on the subsequent sale of the mortgaged property the entire amount of the debt is extinguished.

The Mortgagee may apply to the courts for an Order of Foreclosure and Sale whereby it would be entitled to sell the Property to a third party. The Mortgagee will be entitled to use the purchase price paid by the third party to pay the amount owing by the Mortgagor under the debt obligation and the courts will grant the Mortgagee a judgment against the Mortgagor's other assets for the amount of any deficiency.

In the event that a purchaser cannot be found the court may grant what is referred to as a "Rice Order" allowing the Mortgagee to purchase the property at a price considered by the court to be the fair market value of the Property. The purchase price is satisfied by the extinguishment of an amount of the debt that is equal to the fair market value of the Property and the court will grant the Mortgagee a judgment against the Mortgagor's other assets for the amount of any deficiency.

The Mortgagee may apply to the courts for an order appointing a receiver and empowering the receiver to sell the Mortgagor's assets. The receiver could sell the Property to a third party or the Mortgagee. In the event that the Mortgagee purchases the Property from the receiver then the sale price would be set-off against the debt obligation and the Mortgagee would be entitled to pursue the balance of the debt from the Mortgagor.

In each of the above situations where the Mortgagee acquires the Property, there is no cash consideration paid by the Mortgagee on the transfer of the Property and the Mortgagor has no further rights with respect to the Property after it is transferred to the Mortgagee. For discussion purposes we have assumed that the Property is taxable Canadian property and the Mortgagor is a non-resident person for purposes of the Act.

You are of the view that where the Mortgagee acquires the Property under an Order of Foreclosure and Sale, under a Rice Order or from a court appointed receiver and the price is satisfied only by way of set-off then subsections 116(5) and (5.3) of the Act should not apply. You believe that this conclusion is consistent with the position expressed in paragraph 3 of Interpretation Bulletin IT-150R2 whereby the Department has stated that subsections 116(5) and (5.3) would not be applied where a mortgagee acquires the Property under an Order of Foreclosure. If we were to conclude otherwise then you think it would be impossible for the Mortgagee to comply with the provisions of the Act.

Our Comments

In the case where a mortgagee acquires property by means of an Order of Foreclosure, we believe that the mortgagor's equity of redemption is forfeited and simultaneously transferred to the foreclosing mortgagee. No amount passes to the mortgagee because neither the mortgage nor the mortgage debt is extinguished by the foreclosure. We have therefore concluded that the foreclosing mortgagee would not be considered a purchaser for the purposes of section 116 of the Act. Consequently, the provisions of subsections 116(5) and (5.3) would not apply to a mortgagee who acquires a property by Order of Foreclosure unless the transactions of mortgage and foreclosure were used as a device to sell that property.

In each of the other cases, the Property is being sold to a third party or to the Mortgagee and, as such, we are of the view that there would be a purchaser for the purposes of section 116 of the Act. Therefore, it is our view that subsections 116(5) and (5.3) would apply to the third party or the Mortgagee, as the case may be. In the case of the Mortgagee, the amount paid or credited by the purchaser would be the amount of the mortgage that has been set-off as a result of such purchase.

We regret that our response could not be more favourable.

Yours truly,

for Director
Reorganizations and Foreign Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch