20 February 1996 External T.I. 9530615 - DEBT FORGIVENESS - LIMITED PARTNERSHIP

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:

1.Debt Forgiveness - Partnership. Is section 80 applicable in contemplation of a sale of interest by limited partner?

2.Capital loss to partner?

Position:

1.Section 80(1) applicable - person includes a partnership, forgiven amount may not meet exemption at the time of forgiveness
2.Yes

Reasons:

1.Wording of 80(1) forgiven amount - regular and continous basis
2. It 239R2

		953061
XXXXXXXXXX	C. Tremblay

Attention: XXXXXXXXXX

February 20, 1996

Dear Sirs:

Re: Debt Forgiveness - Limited Partnership

This is in reply to your letter of November 21, 1995, requesting our comments concerning a situation where a general corporate partner active in the management of the business of a limited partnership forgives a debt owing by the limited partnership. The general corporate partner disposes of its interest in the limited partnership as part of a restructuring of the business and financing and the forgiveness was a condition of the sale.

The situation that is described appears to involve a series of actual proposed transactions. It is not our practice to give written opinions concerning proposed transactions, as indicated in Information Circular 70-6R2. Should you wish to request an advance ruling on these or other transactions which may be proposed, please refer to Information Circular 70-6R2 for the procedure to be followed. If, however, your request describes completed transactions involving a specific taxpayer, your questions should be directed to your District Taxation Services Office which has the responsibility of determining the tax consequences of completed transactions and their implications to the specific taxpayers. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which may be of some assistance.

Our Comments

Although a partnership is not a legal entity, a partnership is often described as a contractual relationship and, though often called a contract, is a relationship resulting from a contract. However, for the purposes of section 80 of the Income Tax Act (the "Act"), a "person" includes a partnership. Accordingly, a partnership that receives a loan from a corporate partner would be subject to the rules in section 80 of the Act.

Although the forgiven amount definition found in subsection 80(1) of the Act is nullified in the event that a debtor is an "active" member of a partnership and the obligation has always been payable to an "active" member of the partnership, the "active" member of the partnership must be member of the partnership actively engaged, on a regular, continuous and substantial basis, in partnership activities (other than the financing of the partnership business). Where a managing partner forgives a debt to a partnership of which he is a member as part of a restructuring arrangement whereby he sells his general partnership interest, the obligation issued by a debtor appears to be settled or extinguished at the time the third party purchaser acquires or agrees to acquire the property. Thus, the question is when is a debt considered to be "settled or extinguished". We have been unable to find any Canadian tax jurisprudence with respect to when a debt is "settled or extinguished". However, where a lender that is a partner forgives a loan as part of a restructuring plan or arrangement under which the lender's partnership interest is disposed of, it is our initial view that the lender would not be actively engaged in the partnership business at the time of the forgiveness and accordingly, paragraph (k) of the definition of "forgiven amount" in subsection 80(1) of the Act would not be applicable to the forgiven loan.

Paragraph 80(2)(b) of the Act treats interest payable by a debtor as having a principal amount equal to the portion of the interest that is deductible or that may be capitalized for income tax purposes. It also provides that such interest is also considered to be an obligation issued by the debtor for the same amount.

Pursuant to subparagraph 40(2)(g)(ii) of the Act, a taxpayer's loss arising from the disposition of a debt is deemed to be nil unless the debt had been acquired for the purpose of gaining or producing income from a business or property. Subsection 50(1) deems a debt which has become a bad debt in a taxation year to have been disposed of at the end of that year. A loss resulting from that deemed disposition may also be deemed to be nil by virtue of the provisions of subparagraph 40(2)(g)(ii) of the Act. However only a debt that was previously included or deemed to have been included in income may qualify for the purposes of a bad debt deduction.

The Department's general position is described in paragraph 6 of IT-239R2. Although the bulletin refers to shareholder and corporation, these terms are interchangeable with partner and partnership. Accordingly, where a taxpayer has loaned money at less than a reasonable rate of interest to a Canadian partnership of which he is a partner, subparagraph 40(2)(g)(ii) of the Act will not be applied to any subsequent loss arising to him from the inability of the partnership to discharge its obligations to him if the following conditions are satisfied:

(a)the partnership to whom the loan was made used the borrowed funds in order to produce income from a business or property,

(b)the partnership has made every effort to borrow the necessary funds through the usual commercial money markets but cannot obtain financing without the guarantee of the partner at interest rates at which the partner could borrow.

(c)the partnership has ceased permanently to carry on its business, and

(d)the loan from the partner to the partnership at less than a reasonable rate of interest (or at no interest) does not result in any undue tax advantage to either the partner or the partnership.

In a situation in which the requirement in (c) above is not met, such as in the case when a partner sells his partnership interest of the Canadian partnership to persons who intend to continue operating the partnership's business, and, as a result, also transfers to the purchasers, or settles, his loan at less than face value, the amount by which the adjusted cost base of the partner's debt exceeds the proceeds therefor will be a deductible capital loss if the following conditions as outlined in paragraph 10 of IT-239R2 are met:

(a)the sale of the partnership interest is at arm's length,

(b)the agreement of the partner to accept an amount less than the amount of the debt owing to him must be a condition of the sale of the partnership interest (or antecedent thereto), and

(c)the conditions specified in paragraphs 6(a), (b) and (d) of IT-239R2, as described above, are also applicable to the loan.

Whether a sale is at arm's length is a question of fact. Whether a debt is a "bad debt", subject to the provisions of subsection 50(1) of the Act, is also a question of fact which can only be determined upon an examination of all relevant facts. In this regard, we refer you to paragraph 10 of Interpretation Bulletin IT-159R3 and to paragraph 6 of Interpretation Bulletin IT-442R.

Accordingly, depending on all of the facts of the particular situation, the loss on the loan may qualify as a capital loss.

We trust our comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch