25 February 2010 Internal T.I. 2009-0343601I7 - Debt Forgiveness

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. What tax pools are required to be reduced prior to a subsection 80(13) income inclusion? 2. Under the particular circumstances of this scenario, can the Minister designate the allocation of the forgiven amount to various tax attributes under subsection 80(16) or any other section of the Act? 3. Under the particular circumstances of this scenario, if the year is reassessed pursuant to paragraph 152(4)(a) and an amount is included as income pursuant to subsection 80(13), can the taxpayer then request full designations under subsection 80(5) through (11) pursuant to subsection 220(3.21)? 4. Could they claim a reserve pursuant to section 61.4?

Position: 1. A forgiven amount is to be applied in the following order: 80(3), 80(4), 80(5) then 80(7), 80(8), 80(9), 80(10), 80(11), 80(12) and finally 80(13). 2. No. 3. No. 4. Yes.

Reasons: Application of the Act to the facts of the situation.

									February 25, 2010

CALGARY TAX SERVICES OFFICE					HEADQUARTERS
International & Large Business Directorate		Income Tax Rulings
Attention: Wayne Funk, Large Case Manager	   			Directorate
									L. Carruthers, CA

      								2009-034360

XXXXXXXXXX
Debt Forgiveness

This is in reply to your letter of October 6, 2009, wherein you requested our opinion on the application of the debt forgiveness rules in section 80 of the Income Tax Act (the "Act") to the XXXXXXXXXX , taxation year of XXXXXXXXXX (the "Taxpayer"). We also acknowledge the additional information provided in the Taxpayer's September 29, 2009, letter addressed to you as well as by you in our various discussions, the last of which was on February 5, 2010.

Our understanding of the relevant transactions is as follows:

XXXXXXXXXX : The Taxpayer transferred shares of XXXXXXXXXX . ("Aco") to a related party, electing under subsection 85(1) of the Act. The transaction was reported at a CAD$XXXXXXXXXX capital loss which resulted in a suspended loss pursuant to subsection 40(3.3) and paragraph 40(3.4)(a) of the Act.

XXXXXXXXXX : Control of the Taxpayer was acquired triggering a year-end on XXXXXXXXXX . The suspended capital loss became available to the Taxpayer on XXXXXXXXXX , pursuant to subparagraph 40(3.4)(b)(iii) of the Act, however, it was no longer available to the Taxpayer as of XXXXXXXXXX , pursuant to paragraph 111(4)(a) of the Act.

XXXXXXXXXX : The Taxpayer had CAD$XXXXXXXXXX of related party debt forgiven which was applied against the XXXXXXXXXX , CAD$XXXXXXXXXX capital loss pursuant to subsection 80(4) of the Act and the definition of relevant loss balance in section 80 of the Act.

XXXXXXXXXX : The Canada Revenue Agency's (the "CRA's") Valuation Department appraised the fair market value of the Aco shares transferred on XXXXXXXXXX , to be CAD$XXXXXXXXXX vs. the CAD$XXXXXXXXXX reported by the Taxpayer. This adjustment resulted in a CAD$XXXXXXXXXX capital gain vs. the CAD$XXXXXXXXXX capital loss reported and, therefore, no capital loss should have been available to offset the XXXXXXXXXX , forgiven amount.

XXXXXXXXXX : A protective reassessment of the Taxpayer's XXXXXXXXXX , taxation year was issued assuming the maximum application of the forgiven amount to all tax accounts, effectively reducing all balances to nil by the end of the XXXXXXXXXX year. This reallocation resulted in the disallowance of numerous pool balances and deductions claimed by the Taxpayer in their XXXXXXXXXX , taxation year.

To follow are the specific questions you presented in your October 6, 2009, letter as well as our comments.

Your Question

At what point, under section 80, can the Taxpayer include a forgiven amount into income under subsection 80(13) if no designation has been filed? What tax pools are required to be reduced prior to this income inclusion?

Our Comments

Paragraph 80(2)(c) of the Act provides that a forgiven amount is applied to reduce the tax attributes of the debtor in the numerical order specified, namely, "subsections (3) to (5) and (7) to (13)".

Therefore, unless otherwise provided for, a forgiven amount is to be applied in the following order: subsection 80(3), 80(4), 80(5) then 80(7), 80(8), 80(9), 80(10), 80(11), 80(12) and finally 80(13). However, the wording of subsections 80(5) and 80(7) to 80(11) of the Act result in those subsections not being mandatory, but rather, applying only at the option of the debtor.

Specifically, subsections 80(5) and 80(7) to 80(11) of the Act provide that "the remaining unapplied portion of the forgiven amount" shall be applied:

• "in such manner as is designated" (in subsection 80(5)),
• "to the extent designated" (in subsection 80(7) to 80(9)), and
• "to the extent that it is designated" (in subsection 80(10) to 80(11)).

These expressions indicate that the reductions under subsections 80(5) and 80(7) to 80(11) of the Act are optional, since these provisions only apply to the extent that an amount is designated by the debtor thereunder.

Furthermore, subsections 80(9) to 80(12) of the Act require that, prior to any designation being allowed thereunder, amounts be designated "to the maximum extent permitted" under:

• "subsection (5), (7), and (8)" (in subsection 80(9)),
• "subsection (5), (7), (8) and (9)" (in subsections 80(10) and (80(12)), and
• "subsection (5), (7), (8), (9) and (10)" (in subsection 80(11)).

These expressions indicate that reductions under subsections 80(9) to 80(11) of the Act may only be designated where designations, to the maximum extent possible, have been made pursuant to subsections 80(5) to 80(10) of the Act, as applicable. Furthermore, although subsection 80(12) of the Act is not an optional designation, it only applies where designations, to the maximum extent possible, have been made pursuant to subsections 80(5) to 80(9) of the Act.

In summary, and pursuant to paragraph 80(2)(c) and subsection 80(13) of the Act, a subsection 80(13) income inclusion results only when there remains an unapplied portion of a forgiven amount following:

• the mandatory application of subsections 80(3) and (4) of the Act,
• the optional designations made as allowed by subsections 80(5) to 80(11) of the Act, if any, and
• the application of subsection 80(12) of the Act, if applicable.

Your Question

Can the Minister designate the allocation of the forgiven amount to the various tax attributes under subsection 80(16) or any other section of the Act?

Our Comments

Given that the Taxpayer's XXXXXXXXXX , taxation year is statute barred, the following comments made by the Tax Court of Canada in Leola Purdy (2009 DTC 1042) at paragraph 28 are, in our view, relevant to your question:

"Nobody is saying that a statute-barred year can be reassessed. The tax the taxpayer has been assessed for the statute-barred year cannot be changed. The assessment of tax for the statute-barred year is "deemed valid and binding notwithstanding any error, defect or omission in the assessment..." But it is valid and binding only for the year assessed. If an error was made in the assessment of the statute-barred year which affects another year, the Minister, in assessing the other year, must follow the Act and if there was an error in law in a previous year, including a statute-barred year, that error ought to be corrected so that the assessment for the current year is correct: New St-James Limited, supra, Coastal Construction, supra, Aallcann, supra, Burleigh et al., supra, Cabano, supra, Clibetre Exploration Ltd., supra."

As noted in your letter dated October 6, 2009, in your view, in order to correct the assessment error in the Taxpayer's XXXXXXXXXX , taxation year, the CRA should assume the maximum application of the forgiven amount pursuant to subsections 80(5) to 80(11) of the Act, effectively reducing all balances to nil by the end of the XXXXXXXXXX , taxation year, resulting in every future disposition of shares or interests resulting in a capital gain. However, subsections 80(5) to 80(11) of the Act allow for designations made by the Taxpayer, not the Minister.

Pursuant to subsection 80(16) of the Act, the Minister may only designate the allocation of a forgiven amount to the various tax attributes of a taxpayer when an amount pursuant to section 61.2 of the Act (for resident individuals) or section 61.3 of the Act (for resident corporations) would have otherwise been deducted. So, in our view, without a section 61.3 deduction in the XXXXXXXXXX , taxation year, the CRA may not assume the maximum application of the forgiven amount to all tax accounts, the maximum application of which would have effectively reduced all balances to nil by the end of the Taxpayer's XXXXXXXXXX , taxation year.

Based on our understanding of the submissions by you and the Taxpayer, and given the CRA's CAD$XXXXXXXXXX assessment of the Aco shares disposed of by the Taxpayer, the Taxpayer would have had no capital loss (suspended or otherwise) on the XXXXXXXXXX disposition and, therefore, would have had no relevant loss balance to apply against the XXXXXXXXXX CAD$XXXXXXXXXX forgiven amount. This should have resulted, absent any subsection 80(5) to 80(11) designations, in a CAD$XXXXXXXXXX subsection 80(13) income inclusion. Whether this CAD$XXXXXXXXXX subsection 80(13) income inclusion would have resulted in a section 61.3 deduction is based on whether CAD$XXXXXXXXXX would have exceeded two times the net asset value of the Taxpayer at the end of the XXXXXXXXXX , taxation year.

The Taxpayer has represented that its net asset value, at the relevant time, would have been equal to the increase, if any, in the fair market valuation of the Aco shares over and above CAD$XXXXXXXXXX . Based on this representation, a fair market valuation of CAD$XXXXXXXXXX would have corresponded to an Aco net asset value of CAD$XXXXXXXXXX . Therefore, no section 61.3 deduction would have resulted in the Taxpayer's XXXXXXXXXX , taxation year because the lower limit in paragraph 61.3(1)(b) of the Act would have been nil, i.e., $XXXXXXXXXX - (2 X ($XXXXXXXXXX - $XXXXXXXXXX ))= - $XXXXXXXXXX , or nil.

Therefore, based on the information available, it would appear that the revised CAD$XXXXXXXXXX fair market valuation of the Aco shares would not have resulted in a section 61.3 deduction in the Taxpayer's XXXXXXXXXX , taxation year. Accordingly, in our view, the CRA may not assume the maximum application of the forgiven amount to all ACBs (i.e., CRA may not apply subsections 80(9) to 80(11) of the Act to the maximum extent), such that the ACB's cannot be reduced to nil by the end of the Taxpayer's XXXXXXXXXX , taxation year.

Your Question

If the XXXXXXXXXX , year is subsequently reassessed utilizing subparagraph 152(4)(a)(i) and an amount is included as income pursuant to subsection 80(13) of the Act, can the taxpayer request full designations under subsections 80(5) through (11) pursuant to subsection 220(3.21)? Could they claim a reserve pursuant to section 61.4?

Our Comments

Subparagraph 152(4)(a)(i) reads as follows:

"(4) The Minister may at any time make an assessment, reassessment or additional assessment of tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the year, except that an assessment, reassessment or additional assessment may be made after the taxpayer's normal reassessment period in respect of the year only if

(a) the taxpayer or person filing the return

(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act, or"

In our view, a misrepresentation in the Taxpayer's XXXXXXXXXX , taxation year is as much a misrepresentation in all subsequent years which had been filed by the Taxpayer pursuant to that misrepresentation. This view was also expressed by the Court in Ridge Run Developments (2007 DTC 734) where, at paragraph 165, it was said:

"The Court agrees with counsel for the Respondent that any misrepresentation with respect to 1994 is as much a misrepresentation for 1995, 1996 and 1997 as this amount was carried forward and applied to each subsequent taxation year."

Subsections 80(5) and 80(7) to 80(11) of the Act

Following the application of subsections 80(3) and 80(4) of the Act, the reductions to any remaining unapplied portion of a forgiven amount provided for by subsections 80(5) and 80(7) to 80(11) of the Act are optional, to the extent designated by the debtor "in a prescribed form filed with the debtor's return of income under this Part for the taxation year that includes that time". As noted on the prescribed form T2154, "the designation is not valid unless you file this form with your income tax return for the taxation year in which the debt if forgiven." The Taxpayer did not file a form T2154 with its XXXXXXXXXX , income tax return and, therefore, in our view, it is not entitled to do so now unless there is a provision in the Act allowing such late designation(s).

Subsection 220(3.2) of the Act gives the CRA the discretionary authority to, inter alia, extend the statutory time for filing elections made under prescribed provisions. Pursuant to paragraph 220(3.21)(a) of the Act, any of the subsection 80(5) to 80(11) designations is deemed to be an election under a prescribed provision. Accordingly, the CRA has the discretionary authority to accept a late designation under subsections 80(5) to 80(11) of the Act.

IC 07-1 provides information on the discretionary authority the CRA has under subsection 220(3.2) of the Act and, in our view, the following excerpts from paragraphs 56 and 57 of the IC are relevant to the scenario at hand:

"¶ 56. A request may be accepted in the following situations:

(a) There have been tax consequences not intended by the taxpayer, and there is evidence that the taxpayer took reasonable steps to comply with the law. This could include, for example, the situation where the taxpayer obtained a bona fide valuation for a property, but after the CRA's review the valuation was found to be not correct."

"¶ 57. A request will not be accepted in the following instances:"

"(c) It is reasonable to conclude that the taxpayer had to make the request because he or she was negligent or careless in complying with the law."

In our view, the comments in IC 07-1 paragraph 56(a) are inconsistent with, while those in IC 07-1 paragraph 57(b) are consistent with, a reassessment pursuant to subparagraph 152(4)(a)(i) of the Act and, therefore, following a subparagraph 152(4)(a)(i) reassessment, the CRA would not, in our view, be required to accept a request from the Taxpayer for late designations under any of the subsection 80(5) to 80(11) of the Act.

Section 61.4 of the Act

Section 165 of the Act provides the rules governing a taxpayer's right to object to an assessment by the CRA. In certain circumstances, subsection 165(1.1) of the Act restricts the matters to which a taxpayer may object, to those matters that can reasonably be regarded as relating to any matter that gave rise to the assessment.

A subparagraph 152(4)(a)(i) reassessment is not one of the circumstances under which subsection 165(1.1) of the Act applies. Therefore, in our view, the Taxpayer would be entitled to object to a subparagraph 152(4)(a)(i) reassessment if that reassessment included a subsection 80(13) income inclusion yet disallowed a reserve pursuant to section 61.4 of the Act.

Furthermore, in our view, it would be reasonable to regard a section 61.4 reserve as being related to the matter that gave rise to a reassessment which included a subsection 80(13) income inclusion yet disallowed a reserve pursuant to section 61.4 of the Act. Accordingly, if subsection 165(1.1) of the Act did apply to such a reassessment, the Taxpayer would, in our view, still be entitled to object to that reassessment.

Pursuant to section 56.3 of the Act, any section 61.4 reserve deducted in computing the Taxpayer's income for a taxation year must be included in the computation of the Taxpayer's income for the immediately succeeding year. If the Taxpayer then chooses to have this income inclusion taxed in that latter year, that goal would be achieved by not deducting an amount pursuant to section 61.4 in that latter year.

Subsection 152(4.3) of the Act

Given that the Taxpayer's XXXXXXXXXX , taxation year is also statute-barred, the following comments made by the Tax Court of Canada in Hevey (2005 DTC 203) at paragraph 14 are, in our view, relevant to your reassessment of Taxpayer:

"In my view, the application of subsection 152(4.3) presents no great difficulty in the context of this case. It requires that I consider the following:

i) has there been an assessment or a decision on an appeal?

ii) if so, did it result in a change to a particular balance within the meaning of that word as it is defined in subsection 152(4.4)?

iii) if so, can the reassessment reasonably be considered to relate to that change in the particular balance for the earlier year?

In my view the answer to each of these questions is clearly yes. There was an assessment in relation to the 1994 taxation year, specifically the reassessment of May 28, 1999 that implemented the settlement, and from which no appeal has been taken. It resulted in a change to several balances as defined in subsection 152(4.4) - the taxpayer's income, his taxable income, and his tax payable for the 1994 taxation year."

Subsection 152(4.3) of the Act allows the Minister of National Revenue to reassess beyond the normal reassessment period for a taxation year where a balance is changed from an earlier year. In particular, subsection 152(4.3) specifically provides that a reassessment of tax, interest or penalty payable will be made "only to the extent that the reassessment or redetermination can reasonably be considered to relate to the change in the particular balance of the taxpayer for the particular year." The Technical Notes to subsection 152(4.3) of the Act issued by the Department of Finance include the following statement:

"This provision may be applied, for example, where a decision on appeal has changed the amount of a reserve claimed in a taxation year, and a subsequent taxation year for which an amount relating to the reserve is required to be included, or is allowed to be deducted, in computing income has become barred from reassessment."

Accordingly, in our view, where a subparagraph 152(4)(a)(i) reassessment of the Taxpayer's XXXXXXXXXX , taxation year were to change the amount of a section 61.4 reserve claimed in the year, the CRA could, pursuant to subsection 152(4.3) of the Act, reassess the Taxpayer's XXXXXXXXXX , taxation year to include that reserve amount in computing the Taxpayer's income for XXXXXXXXXX .

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

R.A. Albert, CA
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate