1 February 2010 External T.I. 2009-0338911E5 - 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. Where creditor-shareholders of a CCPC consent to dissolve it, will section 80 of the Income Tax Act (the "Act") be applicable?
2. If the creditor-shareholders elect under subsection 50(1) of the Act, will it cause section 80 to be applicable?

Position: 1. Yes
2. Yes

Reasons: 1. Because the creditor-shareholders are considered to have forgiven the debt.
2. The election triggers a disposition of debt and the application of the debt parking rules.

XXXXXXXXXX 								2009-033891
									V. Srikanth
February 1, 2010

Dear XXXXXXXXXX :

Re: Debt Forgiveness

This is in response to your letter dated August 31, 2009, wherein you requested a technical interpretation on the application of the debt forgiveness rules to a particular scenario.

You presented the following:

1. Opco is a Canadian-controlled private corporation that has ceased to carry on business and that has no assets (and no related tax balances) and no unpaid tax liabilities.

2. Opco's common shares are owned equally by two unrelated individuals.

3. Opco's only debt is an amount that it owes to its two unsecured creditors, who are also its two common shareholders.

4. The creditor-shareholders ("Shareholders") would now like to dissolve the corporation.

Your concerns are:

1. Where the Shareholders of Opco consent to dissolve Opco, pursuant to paragraph 238(1)(c) of the Ontario Business Corporations Act (the "OBCA"), will section 80 of the Income Tax Act (the "Act") be applicable?

2. If the Shareholders of Opco elect under subsection 50(1) of the Act, will section 80 be applicable?

You are further concerned with the possible tax liabilities that may arise if section 80 does apply as Opco has no assets.

Our Comments

Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled Advance Income Tax Rulings. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. If, however, the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office. Your request was not submitted as an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries which are not advance income tax rulings and we are prepared to provide you with the following comments.

Section 80 of the Act applies when a commercial obligation of a debtor, with the exception of an excluded obligation, is settled or extinguished for an amount less than the principal amount of debt. Where section 80 applies, the forgiven amount is applied to reduce 'tax balances' or included in the debtor's income as provided in subsections 80(3) to 80(13).

For purposes of section 80, a commercial obligation is basically an obligation on which interest paid or payable is deductible in computing income, or would be, if interest had been paid or payable in respect of the obligation. An "excluded obligation" is essentially an obligation (or part of an obligation) not taken into account for the purposes of applying section 80 because it is taken into account for purposes of the Act, apart from the rules in section 79 and 80. For example, an "excluded obligation" as defined in subsection 80(1) of the Act includes a loan that has been recognized as assistance for income tax purposes under any one of a number of provisions of the Act (e.g., paragraph 12(1)(x) or subsection 13(7.1)) and amounts payable that have been otherwise included in computing the debtor's income (e.g., subsection 15(2)). The forgiven amount is also defined in subsection 80(1), and with some exclusions, can generally be described as the principal amount of the obligation less the amount paid in satisfaction of the principal amount.

With respect to the meaning of the expression 'settled or extinguished', paragraph 6 of Interpretation Bulletin - 293R, entitled 'Debtor's Gain on Settlement of Debt', states that:

"For a debt or obligation to be "settled or extinguished" all liability for payment must be terminated. Payment, cancellation, set-off, substitution of debtors and release are examples of some possible means of settlement. A debt or obligation is not settled where a creditor abandons his right to enforce payment or becomes statute-barred from enforcing his right to payment."

In the given scenario, no description of the debt was provided, so we assume that the debt is otherwise a debt to which section 80 of the Act would apply, i.e., that as defined for purposes of section 80, the debt is a commercial obligation that is not an excluded obligation. Accordingly, with respect to the two questions posed, section 80 will apply if the actions taken result in the debt being settled or extinguished for an amount less than the principal amount of the debt.

1) Dissolution of the corporation

Where shareholders of a corporation desire to dissolve a corporation, paragraph 238(1)(c) of the OBCA requires that the directors of the corporation certify that the corporation has no debts or other obligations or that any unpaid creditors consent to its dissolution.

In the given scenario, in order to facilitate the dissolution of Opco, if the Shareholders of Opco consent to its dissolution, it would result in the extinguishment of all debts that Opco owed to the Shareholders for no consideration such that the debt forgiveness rules under section 80 would become applicable. The forgiven amount would be the principal amount of the debt and, as you had noted, Opco has no tax balances so that none of the applications or designations that are available under subsections 80(3) to (12) would be available. In such a situation, Opco would have an income inclusion pursuant to subsection 80(13) of the Act equal to 50 percent of the forgiven amount.

However, subsection 61.3(1) of the Act provides a deduction for corporations resident in Canada (other than corporations exempt from tax under Part I of the Act) with respect to amounts included in income under subsection 80(13) because of the application of the debt forgiveness rules. In general terms, section 61.3 requires a debtor corporation to compute the amount of its net assets (i.e., the fair market value of its assets, net of its liabilities) at the end of a taxation year. Subsection 61.3(1) allows an offset against the income inclusion under subsection 80(13) equal to the amount of that income inclusion minus two times the net asset amount. The effect of the offset is that a corporation will be required to recognize income as a consequence of subsection 80(13) only to the extent of twice the corporation's net assets. In a situation where there are no assets, the deduction under subsection 61.3(1) should equal the income inclusion under subsection 80(13) of the Act.

It should be noted that subsection 61.3(3) is an anti-avoidance provision, which provides that the deduction under, inter alia, subsection 61.3(1) is not available to a corporation for a taxation year if property was transferred (or the corporation became indebted) in the 12-month period preceding the end of the year and one of the reasons for the transaction was to increase the amount that the corporation would be entitled to deduct under, inter alia, subsection 61.3(1).

Thus, in the above scenario, it is possible that any amount that may be included in the income of Opco, pursuant to subsection 80(13), may be offset by the application of subsection 61.3(1), subject to the application of subsection 61.3(3).

2) Election under subsection 50(1)

Generally, the debt parking rules will apply when a debt obligation is settled. The debt parking rules under subsection 80.01(8) of the Act will only apply once there is a change in status with respect to a debt.

Under subsection 50(1) of the Act, debts established to have become bad debts by a creditor are deemed to have been disposed of by the creditor for no proceeds and to have been reacquired at a cost of nil. Pursuant to subsection 80.01(6) of the Act, for purposes of the debt parking rules, an obligation is considered to be a 'specified obligation' after the obligation is deemed to have been reacquired pursuant to subsection 50(1) of the Act.

Where an obligation issued by the debtor is a specified obligation, and one of the following conditions is satisfied, i.e.,

• the creditor and debtor do not deal at arm's length, or
• the debtor is a corporation, and the creditor acquired the obligation after July 12, 1994 and owns a significant interest in the debtor,

the obligation will be a parked obligation pursuant to subsection 80.01(7) of the Act.

Subsection 80.01(2) indicates that 'significant interest' pertains to ownership of shares having at least 25% of either votes or fair market value of the issued shares of the corporation. Accordingly, in this scenario, if we assume that the two Shareholders acquired the debt after July 12, 1994, the obligation will satisfy the second condition above and will be a parked obligation.

(If the obligation was acquired prior to July 12, 1994, it would need to be resolved whether the Shareholders do not deal arm's length with Opco. Pursuant to paragraph 251(1)(c) of the Act, it is a question of fact whether persons not related to each other are at a particular time dealing with each other at arm's length. As indicated in paragraph 7 of the Interpretation Bulletin IT-320R3, entitled 'Qualified Investments, Trusts Governed by Registered Retirement Savings Plans, Registered Education Savings Plans and Registered Retirement Income Funds', where the voting power in a closely held corporation is equally divided between two shareholders who are not related persons, the corporation will generally be viewed as being controlled by the group consisting of the two shareholders, but not by either shareholder. However, paragraphs 22 to 26 and 32 in Interpretation Bulletin IT-419R2, entitled 'Meaning of Arm's Length', reflect CRA's general views in determining whether parties to a transaction are not dealing at arm's length. Consideration of those criteria as they apply to the given situation would need to be undertaken.)

Pursuant to subsection 80.01(8) of the Act, in a debt parking situation, a debt is deemed to be settled when two conditions are fulfilled, i.e., 1) the debt has become a parked obligation, and 2) the specified cost is less than 80% of the principal amount of the obligation.

As per subsection 80.01(1), "specified cost" at any time to a person of an obligation means, (a) where the obligation is capital property of the person at that time, the adjusted cost base ("acb") at that time to the person of the obligation, and (b) in any other case, the cost amount to the person of the obligation.

In the above scenario, if the Shareholders of Opco elect under subsection 50(1) of the Act, as discussed above, the debt owed by Opco to the Shareholders, becomes a 'parked debt', i.e., condition 1) above is fulfilled. Also, when the Shareholders elect pursuant to subsection 50(1) of the Act, the debt is deemed to have been disposed for nil proceeds and to have been reacquired at a cost of nil, i.e., the acb of the debt to the Shareholders, is nil, which means the specified cost is less than 80% of the principal amount of the debt. Thus, condition 2) above is fulfilled. As the two conditions set out in subsection 80.01(8) are fulfilled, the parked debt is deemed to be settled and the debt forgiveness rules under section 80 become applicable.

Consequently, if the Shareholders elect under subsection 50(1) of the Act, Opco may have an income inclusion pursuant to subsection 80(13) of the Act. However, as explained above under section 1), Opco may be able to claim relief under the provisions of subsection 61.3(1) of the Act in respect of the income inclusion pursuant to subsection 80(13) of the Act.

We trust our comments will be of assistance to you.

Yours truly,

R.A. Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch