18 June 2010 Internal T.I. 2010-0357321I7 - Application of Section 111 Losses in a Bankruptcy

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: 1. Whether section 128(2) allows s. 111 losses reportedly incurred in the bankruptcy period to be applied post-bankruptcy.
2. Whether section 80 would apply to an amount forgiven in the post bankruptcy period.

Position: 1. Yes.
2. Yes.

Reasons: 1. An individual with bankruptcy losses sustained during bankruptcy may apply the losses incurred in the year of the absolute discharge to post-discharge taxable income, while the trustee may apply the losses incurred in the years prior to the year of the absolute discharge to taxable income for an in-bankruptcy year.
2. S. 80(13) provides for an income inclusion of a settlement, which could include one related to a trade receivable.

							June 18, 2010

	Winnipeg Tax Services Office		HEADQUARTERS
							Income Tax Rulings
							  Directorate
	Attention: Steve Sanderson		Lindsay Frank
	Team Leader, Audit Division		(613) 948-2227

							2010-035732

Application of Section 111 Losses in a Bankruptcy

This is in reply to an email from Dawn Highfield. At issue is whether subsection 128(2) of the Income Tax Act applies to section 111 non-capital losses sustained prior to, and in the taxation year of absolute discharge from bankruptcy, and if not, whether section 80 would apply.

In the instant case, the taxpayer is a proprietor who assigned himself into bankruptcy on XXXXXXXXXX , and received an absolute discharge XXXXXXXXXX , 2002. In 2001 and 2002, he reported non-capital losses of $XXXXXXXXXX and $XXXXXXXXXX , respectively. The losses for 2001 were carried back against income reported in prior years (see below) leaving an utilised loss balance of $XXXXXXXXXX for 2001.

Taxation Year Amount
XXXXXXXXXX

The losses for 2002 were carried forward against income of $XXXXXXXXXX in 2003, thereby decreasing the 2002 loss balance to $XXXXXXXXXX .

XXXXXXXXXX . It is noted that one of these creditors forgave a debt in the amount of $XXXXXXXXXX .

XXXXXXXXXX , the concern here is that the taxpayer may try to carry forward the remaining losses from 2001 and apply them against his income for 2006. Ms Highfield is of the view that paragraph 128(2)(g) would not support such an application. She is uncertain as to whether that provision would also apply to the losses in 2002, and if so, whether section 80 could be invoked.

Pursuant to clause 128(2)(e)(ii)(B), only the trustee can utilise section 111 losses sustained by the taxpayer for a taxation year preceding the year in which the taxpayer received an absolute discharge from bankruptcy. Since the taxpayer received his discharge in 2002, the trustee would be entitled to use the losses reported in 2001, but the losses for 2002 would not be available to the trustee.

On the other hand, subparagraph 128(2)(g)(i) prohibits a taxpayer, who has received an absolute discharge from bankruptcy, from applying section 111 losses carried forward from taxation years preceding the year of discharge. Given that the absolute discharge was granted in 2002, and losses were reported in that year, the taxpayer would be permitted to carry forward such losses. However, the taxpayer would not be able to utilise the losses reportedly sustained in 2001.

Section 80 could apply to the amount forgiven by a creditor subsequent to the bankruptcy. Subsection 80(13) provides for an income inclusion of such a settlement, which could include one related to a trade receivable, see Interpretation Bulletin 293R, Debtor's Gain on Settlement of Debt. It is not known at this time whether the amount forgiven by the creditor was in respect of a trade receivable; accordingly, the amount would need to be analysed further.

Should you have any questions or require additional information on the foregoing, please do not hesitate to contact Lindsay Frank at the telephone number provided above.

B.J. Skulski
Manager
Insolvency and Administrative Law Section
Ontario Corporate Tax Division
Income Tax Rulings Directorate

c.c. Dawn Highfield
Technical Advisor
Audit Division
Winnipeg Tax Services Office