80(1) "commercial obligation"

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: Whether debts released under consumer proposal would result in debt forgiveness under section 80.

Position: Generally yes, if a debt is a "commercial obligation".

Reasons: A release under a consumer proposal would generally result in settlement.

XXXXXXXXXX
2015-056841
Lara Friedlander

May 13, 2015

Dear XXXXXXXXXX:

Re: Impact of Consumer Proposal

This is in response to your email of January 28, 2015 concerning the impact of a consumer proposal undertaken pursuant to the Bankruptcy and Insolvency Act (Canada) (the "BIA").

You have described a situation under which an individual who carries on business has made a consumer proposal under the BIA (the "Proposal") to unsecured creditors. The debts subject to the Proposal included the following:

(a) an overdraft (the "Overdraft") on a bank account;
(b) an amount owing on a credit card (the "Credit Card Debt");
(c) income tax payable and
(d) goods and services tax or harmonized sales tax payable ("GST").

Under the Proposal, the individual would pay a stipulated amount per month for a period of XXXXXXXXXX months for the general benefit of all unsecured creditors. Accordingly, under the Proposal, a portion of each of the debts above would not be paid. We assume that the Proposal has been accepted by the relevant creditors and approved by a court as contemplated by subsection 66.28(2) of the BIA. You have asked us to assume that interest on the Overdraft and the Credit Card Debt is deductible by the individual.

You have asked whether the income tax payable or the GST payable would be a "commercial obligation" as defined in subsection 80(1) of the Act. You have also asked whether the Proposal would result in a full or partial forgiveness of the Overdraft or the Credit Card Debt for purposes of section 80 and, if so, when the forgiveness would occur.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R6, Advance Income Tax Rulings, dated August 29, 2014. Also, where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Nonetheless, we have provided some general comments below.

Our Comments

A "commercial obligation" issued by a debtor is defined in subsection 80(1) of the Income Tax Act (Canada) (the "Act") as

a debt obligation issued by the debtor

(a) where interest was paid or payable by the debtor in respect of it pursuant to a legal obligation, or
(b) if interest had been paid or payable by the debtor in respect of it pursuant to a legal obligation,
an amount in respect of the interest was or would have been deductible in computing the debtor's income, taxable income or taxable income earned in Canada, as the case may be, if this Act were read without reference to subsection 15.1(2) and 15.2(2), paragraph 18(1)(g), subsections 18(2), (3.1) and (4) and section 21…

Paragraph 18(1)(t) of the Act provides that any amount paid or payable under the Act (subject to certain exclusions) is not deductible in computing the income of a taxpayer from a business or property. Paragraph 18(1)(t) also provides that any amount paid or payable as interest under Part IX of the Excise Tax Act (Canada) is not deductible in computing the income of a taxpayer from a business or property. Accordingly, as neither interest on unpaid income tax nor interest on GST payable are deductible, neither the income tax payable nor the GST payable would be a "commercial obligation" as defined in subsection 80(1).

With respect to the potential impact of section 80 on the Overdraft and the Credit Card Debt, generally the debt forgiveness rules apply when there has been a settlement of an obligation. Paragraph 80(2)(a) of the Act provides that "an obligation issued by a debtor is settled at any time where the obligation is settled or extinguished at that time." The Tax Court of Canada in Carma Developers Ltd. v. The Queen, [1996] 3 C.T.C. 2029 (T.C.C.), affirmed at [1997] 2 C.T.C. 150 (F.C.A.), stated at paragraph 24:

In the context of section 80, however, "settle" connotes a final and legal resolution of a taxpayer's obligation whereby that obligation is reduced or brought to an end. It must be considered from the point of view of the taxpayer who would be affected by section 80, not the creditor. Moreover, it must be a final and legally binding termination or reduction of the debtor's obligations.

Similarly paragraph 6 of IT-293R (July 16, 1979) states that "[f]or a debt or obligation to be ‘settled or extinguished' all liability must be terminated."

It is our understanding that section 66.28 of the BIA contemplates the full or partial release of certain debts upon the acceptance of a consumer proposal. It is also our understanding that section 66.3 of the BIA contemplates that a consumer proposal that has been accepted may subsequently be annulled under certain circumstances, including upon default in the performance of any provision of the proposal.

We considered whether a release of a commercial debt obligation under a consumer proposal would result in forgiveness at the time of the release notwithstanding the possibility of a subsequent annulment.

In Lessard v. The Queen, [2003] 3 C.T.C. 2824 (T.C.C.), the taxpayer was assessed for failure to act on a garnishment order. In obiter the Court made the following comments at paragraphs 32 and 36 (in relevant part):

The tax debtor filed a consumer proposal under section 66.13 of the BIA, and the Minister filed a proof of claim in respect of the tax debt which gave rise to the request for garnishment against the appellant. From the moment the consumer proposal was accepted by the creditors and approved by the courts, the tax debtor was released from his debt to the Minister under subsection 66.28(2) of the BIA.…

Accordingly, it appears that the tax debtor is released from his debt to the Minister.

This passage is consistent with paragraph 16 of IT-293R, which states in part: "These provisions [namely the debt forgiveness grinds] may also apply to an insolvent person who has a gain on settlement of a debt by virtue of an approved proposal under Part III of the Bankruptcy Act since such a person is not a bankrupt." Paragraph 25 of IT-293R also states: "the provisions of section 80 apply to situations where there is a bona fide compromise on a trade debt under Part III of the Bankruptcy Act or under other federal or provincial legislation relating to creditors' arrangements and the gain is excluded from the computation of income."

In our view, a full or partial release of a commercial debt obligation under a consumer proposal will generally result in a full or partial forgiveness of the debt at the time of the release notwithstanding that the taxpayer may be required to make payments in the future under the consumer proposal and that a default on such requirement is a possibility.

We trust that these comments will be of assistance.

Yours truly,

G. Moore
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch