Section 143.4

Subsection 143.4(1) - Definitions

Right to reduce

Administrative Policy

26 May 2016 Internal T.I. 2016-0628741I7 - Interaction of s. 80 and s. 143.4

right to reduce notwithstanding that conditions precedent to interest forgiveness not yet satisfied

The Taxpayer, which for a number of years had gone without paying interest on its Notes, had a Plan accepted in Year X and implemented in Year X+1 after a number of conditions precedent had been fulfilled. “Notes, including the Interest Debt, will be settled on the Plan Implementation Date and be replaced with rights to Interest Distributions.” Although the Taxpayer mostly had not deducted the amounts of the Interest Debt, in its return (apparently for Year X), the Taxpayer added such amounts to its non-capital losses at the beginning of the year – then in Year X+1, it deducted the forgiven amount, equalling the difference between the Interest Debt and the fair market value of its assets, from the balance of its non-capital losses.

Did the implementation of the Plan result in the application of s. 143.4(4)?

After describing the Taxpayer as having a right to reduce the Interest Debt that was contingent upon the conditions precedent, stating that such right was “exercisable” as it was “’capable of being made effective in action’ or ‘capable of being implemented’,” and after noting the Taxpayer’s submission that “for a right to be ‘exercisable,’ the taxpayer must have a positive right to reduce an amount,” so that “automatic reductions… beyond the control of the taxpayer would not be caught under the definition of a ‘right to reduce’,” CRA concluded:

[T]he Taxpayer’s right to reduce the Interest Debt is contingent upon a series of conditions that are set out in the Plan, including the Conditions Precedent, and … 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. …

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”… .

Words and Phrases
exercisable
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(2) - Paragraph 80(2)(a) no settlement of debt under Plan before conditions precedent fulfilled 158
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) interest only deductible in the year paid or payable 159
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(4) s. 143.4(4) caused an immediate income inclusion of prior years’ interest that was to be forgiven at a later date under an approved Plan of Compromise 175

Chris Falk, Stefanie Morand and Brian O'Neill, "Is there Always Certainty Regarding Tax Basis? – Limitations on Expenditures Pursuant to Sections 143.3 and 143.4," draft version of paper for CTF 2014 Conference Report.

Does automatic adjustment entail "exercise"? (p. 17)

The first part of the definition captures Collins-like scenarios. What is intended to be captured by the second part of the definition is less clear. Query, for example, whether the definition captures adjustments that occur automatically under a contract (e.g., a price adjustment clause) or is limited in scope to scenarios in which the reduction occurs at the discretion of the taxpayer. While the authors understand, based on informal discussions with the Department of Finance, that automatic adjustments are intended to be captured, the use of the adjective "exercisable", together with the phrase "an amount to the extent that the taxpayer [...] has a right to reduce the amount", provides support for the conclusion that an dement of discretion on the part of the taxpayer is required….

Limitation of contingent amount to potential reduction (p. 17)

Yet another interpretive question is the amount of the "contingent amount" where, for example, a taxpayer incurs an expenditure of $100 and has a right to reduce the expenditure by $20. While the use of the phrase "reduce or eliminate" in the definition of "right to reduce" may give rise to some ambiguity, a contextual and purposive reading of the section strongly supports the conclusion that the contingent amount would be limited to $20.

Potential inclusion of price adjustments or indemnities (p. 17)

Finally, it is unclear whether contingent amounts for purposes of section 143.4 are limited to unpaid amounts or whether the term encompasses refund or reimbursement rights (e.g., rights to payments under indemnity provisions or pursuant to price adjustment clauses)….

Subsection 143.4(2) - Limitation of amount of expenditure

Administrative Policy

2016 Ruling 2016-0661071R3 - Whether s. 80 or s. 143.4 applies

s. 80 prevailed over s. 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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(4) s. 80 rules prevailed in a CCAA compromise over the contingent amount (s. 143.4) rules 300
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) presumption against double taxation applied to oust s. 143.4 56

10 October 2014 APFF Roundtable Q. 15, 2014-0538151C6 F - 2014 APFF Roundtable, Q. 15 - Section 143.4 & Reverse Earn-out

reverse earnout obligation of Buyco re Target shares

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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) - Excluded Obligation reverse earnout obligation of Buyco re Target was excluded obligation 442

Articles

Chris Falk, Stefanie Morand, Brian O'Neill, "Is there Always Certainty Regarding Tax Basis? – Limitations on Expenditures Pursuant to Sections 143.3 and 143.4", 2014 Conference Report, (Canadian Tax Foundation),14:1-36

No grind if up-front payment (p. 19)

Assume, for example that:

  • Taxpayer A purchases capital property from Taxpayer B in exchange for $100, and
  • Taxpayer A has a right to recover $20 from Taxpayer B in the event certain conditions are met and it is reasonable to conclude that that right will become exercisable.

Unless subsections 143.4(2) and (3) are read iteratively, it would seem that Taxpayer A's cost of the property in this example is $100 even if the recovery right is considered to be a contingent amount for purposes of the section. Accordingly, given that the relief afforded in subsection 143.4(3) may not be of assistance if a property is no longer owned at the time of payment, planners may wish to give consideration to having amounts paid up-front…

Subsection 143.4(4) - Subsequent years

Administrative Policy

2016 Ruling 2016-0661071R3 - Whether s. 80 or s. 143.4 applies

s. 80 rules prevailed in a CCAA compromise over the contingent amount (s. 143.4) rules

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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(2) s. 80 prevailed over s. 143.4 108
Tax Topics - Income Tax Act - Section 248 - Subsection 248(28) presumption against double taxation applied to oust s. 143.4 56

26 May 2016 Internal T.I. 2016-0628741I7 - Interaction of s. 80 and s. 143.4

s. 143.4(4) caused an immediate income inclusion of prior years’ interest that was to be forgiven at a later date under an approved Plan of Compromise

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.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(2) - Paragraph 80(2)(a) no settlement of debt under Plan before conditions precedent fulfilled 158
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) - Subparagraph 20(1)(c)(i) interest only deductible in the year paid or payable 159
Tax Topics - Income Tax Act - Section 143.4 - Subsection 143.4(1) - Right to reduce right to reduce notwithstanding that conditions precedent to interest forgiveness not yet satisfied 311

Articles

Chris Falk, Stefanie Morand, Brian O'Neill, "Is there Always Certainty Regarding Tax Basis? – Limitations on Expenditures Pursuant to Sections 143.3 and 143.4", 2014 Conference Report, (Canadian Tax Foundation),14:1-36

Harshness of s. 12(1)(x) inclusion (pp. 19-20)

[T]he consequences of the paragraph 12(l)(x) regime may seem especially harsh and problematic if the expenditure is a capital expenditure (e.g., where the cost of capital property is affected). In some circumstances, it may be possible to elect under subsection 13(7.4) or 53(2.1) to reduce the cost of the property in place of the paragraph 12(1)(x) income inclusion.

No relief where amount paid (p.20)

Further, there is no rule that parallels the relieving rule in subsection 143.4(3). This means that to the extent subsection 143.4(4) applies but the subsequent contingent amount is ultimately paid (or, assuming section 143.4 is considered to extend to amounts that have been paid and an amount is paid up-front, the right to reduce ceases to exist without any amount being recovered by the taxpayer), it will be necessary to establish recognition for the payment elsewhere in the Act. The provisions that typically apply in the context of a paragraph 12(1)(x) amount (e.g., subsection 39(13) and paragraph 20(1)(hh) may not be of assistance….