14 February 1996 Internal T.I. 9601757 - APPLICATION OF SECTION 80 TO A 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:

Section 80 (pre - 1994) - Partnership - As section 80 cannot be applied to a partnership (other than to reduce the tax basis of certain property), can section 9 be used as an alternative to include the amount of the forgiven debt in the income of the partnership (as the debt is directly related to the acquisition of inventory).

Position:

Yes - but only to the extent of inventory (which was purchased with the related debt) on hand at the beginning of the year.

Reasons:

Jurisprudence - Enjay Chemical 71 DTC 5293

February 14, 1996
Toronto Center Tax Services Office Headquarters
Assistant Director, Audit J.P. Dunn
(613) 957-2747
Attention: M. Gaglia
Business Enquiries Group
Section 443 - 6 - 6
960175
XXXXXXXXXX
Application of Section 80 of the Income Tax Act

We are writing in response to your memorandum of January 4, 1996 wherein you had requested an opinion regarding the application of section 80 of the Income Tax Act (the "Act") to the fact situation described below.

Our understanding of the pertinent facts is as follows:

XXXXXXXXXX

6.In 1992, the mortgagors agreed to reduce the principal amount of the mortgage by $XXXXXXXXXX The mortgagors claimed this amount as an allowable business investment loss which claim has been accepted by the Appeals Division.

7.You have proposed that the forgiven amount of the mortgage be added to the income of the partnership pursuant to section 9 of the Act insofar as the expense represented by the forgiven portion of the mortgage has not been, nor will it in the future, be paid and have requested our opinion as to the propriety of this proposed reassessing action.

Generally, it is section 80 of the Act which applies to a forgiveness of debt, however, paragraph 80(1)(a) of the Act, as that provision read prior to the enactment of Bill C-70, is not applicable to a partnership as a partnership has no non-capital, net capital farm or restricted farm losses of its own. Also, paragraph 80(1)(b) of the Act is not applicable in the present circumstances as the partnership owns neither depreciable nor capital property. This is consistent with the statements in paragraph 17 of Interpretation Bulletin IT-138R, "Computation and Flow-Through of Partnership Income" dated January 29, 1979 wherein it is noted that;

Since a partnership has no non-capital losses, net capital losses or restricted farm losses, its gain on settlement of debts within the meaning of section 80 is applied to reduce as prescribed the capital cost to the partnership of any depreciable property and the adjusted cost base to it of any capital property.

The rationale for this statement was posited by the Department in response to question #14 at the Revenue Canada Roundtable session at the 1988 conference of the Canadian Tax Foundation wherein it was stated that'

This treatment results from the provisions of subsection 96(1) whereby the partnership calculates its income as though it were a separate person - that is, as though the provisions of the Act applied to the partnership as a taxpayer who then allocated to each partner his or her appropriate share.

However, at paragraph 25 of Interpretation Bulletin IT-293R, "Debtors Gain on Settlement of Debt", dated July 16, 1979, it is noted that,

...forgiveness of a trade debt in the same taxation year in which it was incurred is required to be included in computing the debtor's income for that year under the general rules for computing profit from a business or property. Where the debt forgiven is in respect of merchandise or other property in which the debtor deals, the cost of the property acquired is reduced by the amount of the forgiveness whether or not it was sold in the year in which the debt was forgiven. Where the forgiveness occurs in a taxation year subsequent to that in which the debt was incurred, the same general rules of profit computation require that an amount be included in the profit computation for the year of forgiveness equal to that portion of the forgiven debt that relates to the inventory of merchandise on hand at the beginning of that year.

In accordance with the above paragraph, should the mortgage be found to be a trade debt, section 9 of the Act will be applicable. Should, however, the debt be found to be on account of capital, the forgiveness would be considered a capital item and, in the absence of the provisions of section 80 of the Act, not subject to tax.

This view is supported by the comments of Cartwright J. in Tip Top Tailors Limited v. The Minister of National Revenue, 57 DTC 1232 (S.C.C.) as quoted by Walsh J. in Minister of National Revenue v. Enjay Chemical Co. Limited 71 DTC 5293 (F.C.T.D.) at page 5300 wherein it was stated that,

...I can find nothing sufficient to displace this prima facie presumption that a saving made in discharging an obligation to a lender is properly treated as an item of capital and not of revenue.

The Enjay case concerned the forgiveness of a portion of a trade account payable by the vendor when the market price of the commodity decreased subsequent to its purchase by the respondent company. In distinguishing that case from the circumstances in Tip Top Tailors, the Court noted at page 5300 that,

In the present case we are, of course, dealing with the relationship of vendor and purchaser and not of lender and borrower...

And further, at page 5301, the Court comments on the consequences flowing from the distinction in the relationship between the parties when it is stated that;

If it is found that the forgiveness of debt in this case was of a capital nature then the British Mexican case clearly applies and it is not taxable, but, if on the other hand, it is considered that it was in the nature of a discount or subsidy paid to supplement the respondents trading receipts, then the Lincolnshire Sugar and Oxford Motors cases apply.

The Court ultimately found, in Enjay, that the amount of forgiveness constituted a rebate and the amount was included in the income of the corporation by way of adjusting the value of its inventories in the year of the forgiveness and the year subsequent.

In the present case, the relationship between the XXXXXXXXXX and the partnership is one of vendor and purchaser and not of lender and borrower and, consequently, it is our view that the above paragraph 25 of Interpretation Bulletin IT-293R, and especially the final sentence thereof, is directly applicable to the present situation such that the cost of the opening inventory of land held for development should be reduced by the forgiven debt applicable to its purchase. In this case, this amount would be $XXXXXXXXXX being the value of the inventory of land at the beginning of the 1992 taxation year.

With respect to the balance of the forgiven amount of $XXXXXXXXXX it is our view that this balance cannot be included in the income of the partnership pursuant to section 9 of the Act. As noted several times in the Enjay case (and as discussed at length in the British American case), the release in a subsequent year from a liability which had been correctly stated in the year in which it was initially incurred cannot be considered an item of income in the year of release. Accordingly, the relevant jurisprudence would not support the inclusion of the forgiven amount in income except to the extent that the value of the inventory on hand at the beginning of the year is reduced as discussed previously.

Also, we would agree with your comments regarding the application of section 80 of the Act to a joint venture and would disagree with the contention of the taxpayer's representative that the current assessing position with respect to a partnership is inconsistent with that as applied to a joint venture. Because the joint venture is not a legal entity, the debts are not those of the joint venture but rather are those of the joint venturer and, accordingly, any forgiveness of those debts is a forgiveness of a liability of the individual or corporate joint venturer which would result in the application of section 80 to that person.

We trust that this is the information which you require.

Section Chief
Leasing and Finance Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch