Section 143.4

Under a CCAA Plan, unpaid interest of a corporation that had accrued in the current and prior years would be forgiven. Once the Plan was approved, s. 143.4(4) would require there to be an accounting at the end of the year of the Plan implementation for an income inclusion equal to the prior years’ forgiven interest. Furthermore, there would be a denial of current years’ interest under s. 143.4(2). However, CRA found that, given that s. 80 applied in the same year, and in light of the rule of statutory construction according prevalence to the more specific provision and the rule against double-taxation in s. 248(28), ss. 143.4(2) and (4) would not also apply.

A newly formed corporation ("Newco") purchases the shares of a target corporation ("Target") for consideration that includes an earn-out clause (resulting in a debt which is subsequently forgiven). Newco and Target amalgamate, so that the shares of Target are cancelled. Would a reduction in the cost of the shares of Target (through the application of subsection 143.4(2) of the ITA) prior to the subsequent amalgamation of Target with Newco cause the debt to qualify as an "excluded obligation" (as defined in subsection 80(1) of the ITA), so that the settlement of the debt following the amalgamation should not result in a "forgiven amount" (as defined in subsection 80(1) of the ITA)? CRA responded (TaxInterpretations translation):

[Y]ou have assumed that Newco, at the time of the acquisition, has an existing legal obligation to pay the maximum purchase price, so that ITA subsection 143.4(2) would be applicable at the time of the acquisition of the shares respecting the unpaid purchase price, and that the purchase price would be extinguished after the amalgamation. It is not possible to provide definitive responses without knowing all the facts of a specific case. However we can offer the following general comments which nonetheless, in some circumstances, would not apply in a particular situation. …

…(a)…[A] reduction in the cost of the shares in the capital stock of Target through the application of subsection 143.4(2) prior to the amalgamation would in general permit the debt to qualify as "excluded obligation" as defined in subsection 80(1), by reason of the application of paragraph (a) of that definition.

Paragraph (d) of the definition of "excluded obligation in general could not apply because the debt was of a capital nature.

Pursuant to a Plan of Compromise and Arrangement under the CCAA (the “Plan”):

1. A wholly-owned subsidiary of the taxpayer will be wound-up, with a s. 80.01(4) election being made on a timely basis.
2. Interest on “Affected Claims” (including bank loans and notes) that accrued both in the current year and prior years (the “Unpaid Interest”) will be forgiven.
3. The Taxpayer will issue “Claim Settlement Shares” to Affected Creditors in satisfaction of their Affected Claims (except that “Cash Election Creditors” will receive cash in lieu of such shares – apparently funded out of common share subscriptions by the Plan Sponsor and investors), thereby resulting in a portion of the outstanding principal of the Affected Claims being forgiven

The resulting forgiven amount is estimated to be less than the taxpayer’s tax attributes.

Rulings

Re application of s. 80 in the year of settlement and that, on the basis of s. 80 applying, ss. 143.4(2) and (4) will not apply to any right to reduce the Unpaid Interest that might arise in that taxation year. In its reasons, CRA stated:

According to the rules that govern the application of a "forgiven amount," such as subsection 80(3), if a commercial debt obligation is forgiven at any time, the forgiven amount is applied to reduce the particular balance "at that time." On the other hand, under subsection 143.4(4), the "subsequent contingent amount" is deemed to be an amount received under subparagraph 12(1)(x)(i) at that time, but under section 12, an amount is included in income "for a taxation year," which is only accounted for at the end of a taxation year. Further, although there is no carve out under section 143.4 for forgiven amounts, section 143.4 would not apply by virtue of the prohibition against double taxation under subsection 248(28) and the rule that a more specific provision takes precedence over a more general provision.

In Year 1 a Plan was approved which entailed a forgiveness of unpaid interest that had accrued in prior years. However, the Plan’s implementation did not occur until Year 2, when the stipulated conditions precedent were satisfied. Rather than s. 80 applying to the forgiven interest in Year 2, its amount was in CRA’s view included in the debtor’s income in Year 1 under s. 143.4(4). CRA found that:

[T]he Taxpayer’s right to reduce the Interest Debt … falls within the definition of a “right to reduce” in subsection 143.4(1) because it is reasonable to conclude, having regard to all the circumstances, that the right will become exercisable [i.e., that the conditions precedent would be thereafter satisfied].

Further, even if the Interest Debt is settled in a subsequent year, there should be no double taxation [given] (a)(i) of the definition of “excluded obligation”… .

CRA did not discuss whether there still would have been an s. 143.4(4) income inclusion, rather than an application of the debt forgiveness rules, if the Plan had been implemented in the same year.