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.
Principal Issues: Would section 79.1 of the Income Tax Act (the "Act") apply where, as a result of the debtor's failure to pay a debt, the creditor seizes shares of the debtor or of a partnership interest in the debtor?
Position: No
Reasons: The property referred to in paragraph 79.1(2)(a) of the Act must, in our view, have been held by the debtor and, therefore, would not include an ownership interest in the debtor (i.e., would not include shares of, or a partnership interest in, the debtor).
TAX EXECUTIVES INSTITUTE, INC.
December 6, 2011
Question 14 - Section 79.1 Seizure of Property Effect on Creditor
Section 79.1 applies when a property is seized at any time by a person in respect of a debt. Under subsection 79.1(2) "a property is seized at any time by a person in respect of a debt where (a) the beneficial ownership of the property is acquired or reacquired at that time by the person; and (b) the acquisition or reacquisition of the property is in consequence of another person's failure to pay to the person all or part of the specified amount of the debt."
We invite CRA's reactions to the following issues about seizures.
Question 14.1
In TEI's view, where a creditor seizes any property, which may include, but is not limited to the property used to secure the debt, from a debtor in respect of a debt, section 79.1 should apply because the statute refers broadly to seizure of "a property" acquired by a creditor as a result of the debtor's failure to pay the debt. (The statute is not limited to a seizure of the property that secures the debt.) For example, property seized may be shares of the debtor or a partnership interest in the debtor. We invite CRA's comments on the issue.
CRA's Response
We concur with your view that the property referred to in paragraph 79.1(2)(a) of the Income Tax Act (the "Act") may include, but is not limited to, a property used to secure the debt referred to in paragraph 79.1(2)(b) of the Act. However, as described in the Department of Finance's 1995 Technical Notes, section 79.1 of Act contemplates a creditor seizing property surrendered by the debtor or previously transferred from the original debtor to a third party and there is no creditor/debtor relationship between the third party and the creditor. Therefore, in our view, the property referred to in paragraph 79.1(2)(a) of the Act must have been held by the debtor and would not include an ownership interest in the debtor (i.e., would not include shares of, or a partnership interest in, the debtor).
Question 14.2
For purposes of section 79.1, a property is considered seized by a person when "(a) the beneficial ownership of the property is acquired or reacquired at that time by the person." The term "beneficial ownership" is not defined for purposes of this section. We invite CRA's comments its interpretation of the term in the context of section 79.1.
With respect to each of the following scenarios, please comment on whether the creditor acquires a beneficial ownership in the Asset.
CRA's Response
Whether a person acquires beneficial ownership of a property is a question of fact that can only be made after consideration of all the facts and circumstances of a particular case. The concept of legal and beneficial ownership for tax purposes is discussed in Interpretation Bulletin IT-437R, Ownership of Property (Principal Residence). Paragraph 4 of IT-437R states:
¶ 4. Beneficial ownership must be distinguished, however, from the other types of physical possession of property which a person may enjoy. For example, a tenant of a property, or a person who is allowed to occupy it only because the true owner has no objection, is not the beneficial owner of the property. In determining whether a person has beneficial ownership, one should consider such factors as the right to possession, the right to collect rents, the right to call for the mortgaging of the property, the right to transfer title by sale or by will, the obligation to repair, the obligation to pay property taxes and other relevant rights and obligations. Not all of these incidents of ownership need occur concurrently before it is concluded that the person has beneficial ownership of the property, which is a question of fact in each particular case (subject to any determination under the law regarding beneficial ownership such as, for example, in the manner described in ¶s 6, 8 or 9 below).
Scenario A
Company A owes an outstanding debt to a creditor and also owns an Asset that secures the debt. Company A defaults on the debt and, following negotiations between the creditor and Company A shareholders, the creditor acquires the shares of Company A. The debt is extinguished.
Would CRA's view change if the debt is not extinguished?
CRA's Response
In the above scenario, the creditor has not acquired beneficial ownership of the Asset but rather has acquired beneficial ownership of the shares of Company A which owns the Asset.
Our view would not change if the debt was not extinguished. The question of whether a property is seized for the purposes of section 79.1 of the Act is not dependent on extinguishment of debt but rather on a person's failure to pay the creditor all or part of the debt. In fact, where any portion of the particular debt is outstanding immediately after that time, paragraph 79.1(7)(c) of the Act provides for the determination of the creditor's cost amount of that portion of the debt.
Scenario B
A Partnership owes an outstanding debt to a creditor and owns an Asset that secures the debt. The Partnership defaults on the debt and following negotiations between the creditor and partners of the Partnership, the creditor acquires an interest in the Partnership. The debt is extinguished.
Would CRA's view change if the debt is not extinguished?
CRA's Response
In the above scenario, the creditor has not acquired beneficial ownership of the Asset but rather has acquired beneficial ownership of an interest in the Partnership which owns the Asset.
Our view would not change if the debt was not extinguished.
Scenario C
A Limited Partnership owes an outstanding debt to a creditor and owns an Asset that secures the debt. The Partnership defaults on the debt and following negotiations between the creditor and partners of the Partnership, the creditor acquires shares of a corporation that is a General Partner of the Partnership. The debt is extinguished.
Would CRA's view change if the debt is not extinguished?
CRA's Response
In the above scenario, the creditor has not acquired beneficial ownership of the Asset but rather has acquired beneficial ownership of the shares of a corporation that is a General Partner of the Partnership which owns the Asset.
Our view would not change if the debt was not extinguished.
Scenario D
Company A owes an outstanding debt to a creditor and owns an Asset that secures the debt. Company A defaults on the debt. The creditor incorporates a subsidiary. Following negotiations between the creditor and Company A, the subsidiary of the creditor acquires the Asset from Company A in exchange for the assumption of the debt.
CRA's Response
In the above scenario, the creditor has not acquired beneficial ownership of the Asset but rather the subsidiary of the creditor has acquired beneficial ownership of the Asset.
Scenario E
Company A owes an outstanding debt to a creditor and owns an Asset that is used to secure the debt. Company A defaults on the debt. The creditor incorporates a subsidiary. Following negotiations between the creditor, the subsidiary, and Company A, the Asset is transferred to the subsidiary and the debt is extinguished.
CRA's Response
In the above scenario, the creditor has not acquired beneficial ownership of the Asset but rather the subsidiary of the creditor has acquired beneficial ownership of the Asset.
Lori Carruthers
2011-042710
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