Section 80

Forco, a wholly-owned subsidiary of Canco, borrowed under a secured "Borrowing" from a lending syndicate, with Canco providing a guarantee" secured by, inter alia, its shares of Forco and with no fee being charged by it. Canco also guaranteed various contractual obligations of Forco. Forco became insolvent, both guarantees (the "Guarantees") were called and Canco commenced CCAA proceedings. There was an insufficiency after a sale of Forco, and Canco defaulted on its Guarantees.

In finding that s. 80 did not apply in respect of the forgiveness of amounts owing by Canco under the Guarantees, the Directorate noted (respecting s. 20(1)(c)(i)) that "Canco should not be considered to have borrowed money under the Borrowing" and (respecting s. 20(1)(c)(ii)) "the amounts owing by Canco were not amounts payable for property acquired for the purpose of gaining or producing income from property." Accordingly, the Guarantee obligations were not commercial debt obligations.

A compromise by Aco under Division I of Part III of the Bankruptcy and Insolvency Act resulted in reassessments owing by Aco for unremitted GST and QST including interest and penalties being compromised for the payment of a stipulated sum under a stipulated schedule. After finding that the forgiveness "gain" was not income under s. 9, CRA stated (TaxInterpretations translation) that:

[T]he portion of the amount of the gain arising from the settlement of the unremitted GST and QST (including interest and penalties) would not be subject to …section 80 given that such [amounts]…would not be considered as an "obligation issued" by the debtor under the terms of subsection 248(26), as is required by the definition of "commercial debt obligation" in subsection 80(1).

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. (a) 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)? (b) When the transaction (and related debt) occurred in a taxation year ending before March 16, 2011 (so that s. 143.4 does not apply due to the transitional rule), or there was no "right to reduce", would the fact that the shares no longer exist after the amalgamation and that their cost is therefore not reduced, result in a "forgiven amount" because the debt that is settled would not qualify as an "excluded obligation" as per s. 80(1)? 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.

…(b) In such situations, it appears to us that in general the extinguishing of the debt could generally give rise to a "forgiven amount" given that the debt would not qualify as an "excluded obligation" as per the definition provided in paragraph 80(1).In the situations presented in this question (with ITA subsection 143.4(2) not being applicable), the fact that the shares no longer existed following the amalgamation and that consequently their cost would not be reduced, does not appear relevant to the question of there being a "forgiven amount" as defined in paragraph 80(1).

"A reduction of the eligible capital expenditure of a taxpayer pursuant to paragraph 14(3)(b) of the Act is a result contemplated by subparagraph (a)(iii) of the definition of 'excluded obligation' in subsection 80(1) of the Act."

In response to a question whether s. 80 would apply where a creditor waived the right to receive accrued and payable interest on a debt, the Directorate indicated that where the forgiven interest amount is determined to be on account of capital, s. 80 is applicable irrespective of whether or not the amount was forgiven in the same or subsequent taxation year.

Immediately before the winding-up of a partnership under s. 98(5), the general partner assumed a debt that was owing to it by the partnership, with the result that the debt was extinguished by operation of law. CRA ruled that this did not result in a forgiven amount.

Background

As described in 2015-0601441R3, Sub1 and Sub2 (both taxable Canadian corporations and wholly-owned subsidiaries of Parent, a public corporation) accomplished a winding-up of a general partnership (“Partnership”) through a transfer under s. 85(1) by Sub2 of its interest in Partnership to Sub1 in consideration for Sub1 Preferred Shares and for a non-interest bearing demand promissory note (the “Sub1 Note”) with a principal amount equal to the non-interest-bearing demand promissory note (the “Sub2-Partnership Note”) owing by Sub2 to the Partnership, jointly electing under s. 85(1).

Proposed transactions

1. The Sub1 Note and the Sub2-Partnership Note will be settled in full by way of set-off.
2. Sub1 will redeem the Sub1 Preferred Shares held by Sub2. The redemption amount will be satisfied by the issuance of a non-interest bearing promissory note (the “Sub1 Redemption Note”).
3. Sub2 and Parent will undertake a s. 86 reorganization of Sub 2’s capital so that, following articles of amendment, Parent will exchange all of the issued and outstanding shares of Sub2 for Sub2 New Common Shares and (non-voting redeemable retractable) Sub2 Preferred Shares. The aggregate redemption amount of the Sub2 Preferred Shares will be equal to the amount owing by Sub1 under the Sub1 Redemption Note, and the aggregate FMV of the Sub2 New Common Shares and Sub2 Preferred Shares will be equal that of the exchanged Sub2 Shares, which will be greater than the FMV of the Sub1 Redemption Note.
4. Parent will transfer to Sub1 all of the Sub2 Preferred Shares (the “Transferred Sub2 Shares”) in consideration for the issuance of Sub1 common shares (the “New Sub1 Shares”), electing under s. 85(1) at Parent’s ACB of the Transferred Sub2 Shares.
5. Sub2 will redeem the Transferred Sub2 Shares held by Sub1. The redemption amount will be satisfied by the issuance of a non-interest bearing promissory note (the “Sub2 Redemption Note”).
6. The Sub1 Redemption Note and the Sub2 Redemption Note will be settled by way of set-off and cancelled in full satisfaction of the obligations under the Sub1 Redemption Note and the Sub2 Redemption Note.

Ruling

Provided that the amount owing under the two notes is equal, s. 80(1) will not apply to the settlements in 6. The summary answered the question of “Whether administrative position in respect of section 80 applies” with “No,” stating: “Set-off and cancellation of debts not occurring in context of a distribution as defined in subsection 55(1).”

Described steps included the holder of a "Newco note" (Holdco) transferring the Newco note to Newco (the debtor) as a capital contribution or share subscription. CRA did not comment on the debt forgiveness rules.

Lossco, an indirect subsidiary of Parent, will make interest-bearing loans to (profitable) Parent, and Parent will subscribe for redeemable retractable preferred shares of Lossco ("prefs"). On the unwinding following utilization of Lossco's losses, Lossco will redeem the prefs by delivering the loans which it made to Parent. Ruling inter alia that such delivery of the loans on the pref redemption will not give rise to a forgiven amount.

An insolvent (but not bankrupt) company negotiates a settlement with CRA of unpaid source deductions and unremitted GST for less than the balance owing. Would this give rise to a forgiven amount or other income? CRA stated:

[I]nterest and penalties assessed under the ITA are not deductible (see section 67.6 and paragraph 18(1)(t)…). As such, the debt owed by the company…would not satisfy the definition of a commercial debt obligation and therefore, the debt forgiveness rules would not apply.

However, the amount as it related to source deductions would be included in income under s. 9, and under s. 12(1)(x) as it related to GST.

IT-293R continues to reflect CRA's view that para. (i) of the definition of "forgiven amount" does not apply in circumstances in which a bankruptcy is annulled as the result of a proposal under Part III of the Bankruptcy and Insolvency Act.

A unit trust (Trust 1) purchases for cancellation of most of its units held by its parent (Subco) in consideration for the transfer to Subco of debt owing by Subco. Ruling that no forgiven amount.

Aco is a Canadian public company holding interest-bearing promissory notes (Bco Notes) and shares of a Canadian subsidiary (Bco). Preliminarily to a Plan of Arrangement:

• Aco will transfer the Bco Notes (having an adjusted cost base equal to their principal) to a newly-incorporated CBCA corporation (Newco1) in consideration for the issuance of Newco1 common shares
• Aco will transfer its Newco1 common shares to Bco in consideration for the issuance of a nominal number of Bco common shares
• the paid-up capital of the Newco1 common shares will be reduced
• Newco1 will be wound-up into Bco, with Bco making a s. 80.01(4) election
• a CBCA corporation (New Aco) will be incorporated

Under the Plan of Arrangement:

• convertible debentures owing by Aco will be converted into Aco common shares
• Aco (and New Aco on its behalf) will deliver or issue cash, Aco senior notes, Aco debentures exchangeable into New Aco common shares and New Aco common shares in exchange for the debt (which is then cancelled) of existing debt holders of Aco – with Aco thereafter issuing first preferred shares and notes to New Aco in consideration for the issuance of the New Aco common shares to such debt holders
• the pre-Arrangement common and preferred shares of Aco will be purchased by Aco in consideration for the delivery of New Aco common shares and cashless warrants to acquire New Aco common shares

Rulings:

• ss. 40(2)(e.1) and 53(1)(f.1) will apply to the dispositions of the Bco Notes to Newco1, so that their ACB is preserved
• the extinguishment of the Bco Notes on the winding-up of Bco will not give rise to a forgiven amount (per s. 80.01(4))
• interest on the debt issued by Aco to the former debt holders will be deductible provided the interest on the former debt was deductible
• capital losses arising to Aco under s. 111(4)(d) on the acquisition of its control by New Aco [i.e., because its first preferred shares are voting?] will form part of its capital losses for its taxation year ending immediately before such acquisition of control for purposes of s. 80(12)
• the settlement of the debt of Aco will result in a forgiven amount
• s. 245(2) will not apply

On an open market purchase of liquid yield option notes ("Lyons"), s. 80 will not apply on the repurchase if s. 39(3) so applies (i.e., there is a gain on capital account). CRA stated:

[S]ubsection 39(3)...allow[s] for a capital gain or capital loss where a taxpayer purchases in the open market any obligation earlier issued by the taxpayer and these provisions would apply in these current circumstances. The provisions do not...affect transactions which are income transactions under the general rules for distinguishing income from a capital gain. ...Subsection 248(27) of the Act clarifies that the open market purchase of any portion of an obligation under subsection 39(3) of the Act is treated on the same basis as the purchase of the entire obligation. Further, the definition in subsection 80(1) of the Act of "forgiven amount", at paragraph (d) of the formula calculating B, clarifies that any portion of a debt extinguished under circumstances to which subsection 39(3) of the Act applies is not subject to the application of subsection 80(1) of the Act. Subsection 39(3) of the Act overrides any of the more general provisions. Accordingly, in our view, section 80 would not apply in the situation described.

Respecting the situation where a wholly-owned corporation with an accounting deficit was wound-up pursuant to s. 238(1)(e) of the Business Corporations Act (Ontario), the Agency noted that paragraph (i) of the definition of forgiven amount did not apply to a person who was an insolvent person but did not have the legal status of a "bankrupt". S.61.3(1) of the Act in effect provided that an insolvent corporation was required to recognize income as a consequence of s. 80(13) only to the extent of twice the amount of its net assets.

"Section 79 has priority over section 80 except if paragraph 80.01(8) has applied in a previous year." [Translation]

Where a corporation that is active in the operations of a particular partnership is not a member of the particular partnership but, instead, is a member of a partnership which, in turn, is a member of the particular partnership, the exemption in paragraph (k) of the definition of "forgiven amount" will not be available.

Where following an acquisition of control of a subsidiary, non-capital losses and net capital losses of the subsidiary for taxation years ending before the acquisition of control are precluded from being carried forward under the rules in s. 111(5) and (4), such losses would not be includible in the relevant loss balance of the parent following a winding-up of the subsidiary under s. 88(1) given the application of the rules in s. 88(1.1)(b) and 88(1.2)(b) unless the condition in s. 88(1)(1.1)(e) continued to be satisfied at the time of the wind-up. However, such losses generally would be included in the amalgamated corporation's relevant loss balance by virtue of s. 87(2.1) if the subsidiary instead was amalgamated with the parent corporation under s. 87(1), provided that the restrictions in para. (d) and (e) of the relevant loss balance definition did not apply.

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.

CRA indicated that, as the conditions precedent had not been satisfied, and the Plan implementation did not occur, in Year X, the settlement did not occur, and s. 80(2) did not apply, in that year.

Respecting the situation where an employee debt became statute-barred, and the employer then wrote it off because it was thus no longer legally collectible, CRA considered this writing-off to be sufficient to trigger s. 6(15).

In the course of a general discussion, CRA stated:

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:

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. Moreover, it must be a final and legally binding termination or reduction of the debtor's obligations.

… The Queen v. Diversified Holdings Ltd., [1997] 2 C.T.C. 263 (F.C.A.)… dealt similarly with this issue.

Before going on to note that the debt parking rules in ss. 80.01(6) and (8) would in any event deem the debt to be forgiven, CRA noted that in the circumstances there might also be a settlement of the debt for nil consideration on more general principles, and quoted a statement 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.), that "'settle' connotes a final and legal resolution of a taxpayer's obligation whereby that obligation is reduced or brought to an end… ."

Generally, it is the view of RC that s. 80 does not apply to an economic defeasance arrangement.

"Section 80 would apply where a son repays a commercial debt obligation owing to his father from a gift received immediately before and for the sole purpose of repayment of the commercial debt obligation."

In the course of a general discussion, CRA stated:

Paragraph 80(2)(b) of the Act is a deeming clause, and, in essence, it provides that for the purposes of subsections 80(1) and (3), an amount of interest in respect of a debt shall be deemed to be a debt issued by a taxpayer that has a principal amount. Therefore, subsections 80(1) and paragraph 80(2)(b) of the Act, read together, apply both to the principal amount of a debt in its ordinary sense and the amount of the debt that is made up exclusively of interest deducted or deductible by the debtor.

In response to a question as to whether s. 80 would apply where interest is waived and forgiven in the same taxation year in which it was accrued, or whether such interest should be included in the debtor's income for that year by virtue of s. 9, CRA noted that where the gain on the settled debt is of an income nature, the debt is an excluded obligation (so that s. 80 does not apply), and stated that where the debt

is a trade debt or on account of income, it may be included in the taxpayer's computation of profit under section 9 of the Act. If the debt is considered on account of capital, section 80 of the Act may apply.

CRA concluded:

Therefore, where the interest amount is determined to be on account of income, and the interest on the debt is forgiven in the same taxation year in which the interest expense is deducted or deductible, the interest amount is included in income in that same taxation year. Generally, where such amount is forgiven in a subsequent year, in our view, section 80 of the Act will apply.

Although a price adjustment clause may be used for satisfying the requirements of s. 80(2)(g), "an acceptable price adjustment clause should not involve the cancelling of issued shares or the issuing of additional shares".

Where a debt denominated in U.S. dollars was replaced by a new debt obligation denominated in Canadian dollars whose amount was equivalent to the U.S.-dollar debt at the current exchange rate, there would be a foreign exchange gain recognized and no forgiven amount recognized.

There is no forgiven amount where one commercial debt obligation is exchanged for another commercial debt obligation having the same principal amount.

Ruling that when a Canadian debtor is wound-up into its Canadian parent and an election under s. 80.01(4)(c) is made, then, in light of s. 80(2)(k), no gain or loss will be realized under s. 39(2).

Where a debt denominated in U.S. dollars was replaced by a new debt obligation denominated in Canadian dollars whose amount was equivalent to the U.S.-dollar debt at the current exchange rate, there would be a foreign exchange gain recognized and no forgiven amount recognized.

"Paragraph 80(2)(o) of the Act results in section 80 only applying to the particular person for his proportionate share ... . Section 80 of the Act will not apply with respect to the settled amount to any of the other debtors other than the particular person."

After the taxpayer had settled a commercial debt obligation so as to give rise to a forgiven amount, it was assessed by CRA to increase its taxable income for two other taxation years. CRA acceded to the taxpayer’s request to apply non-capital losses (NCLs) which the taxpayer had sustained in taxation years preceding that of the debt settlement because it was not yet aware of the debt settlement, as the return for the debt-settlement year had not yet been filed. When the return was filed, the taxpayer applied the forgiven amount against its undepreciated capital cost balance.

In finding the forgiven amount should have instead reduced the NCLs that had been incorrectly applied to carryover to the assessed taxation years, the Directorate stated:

Where a debt settlement occurs, element D.2 of the definition of NCL in subsection 111(8) reduces the amount of the NCL in a taxation year by the amount of the reduction that results from the application of section 80. Consequently, the NCL for each taxation year that ended before the time of settlement of the debt is reduced within the limits set out in paragraph 80(3)(a). The NCL reduction for a taxation year due to a debt settlement is applicable from the moment the debt settlement takes place.

In other words, the settlement of a commercial debt that results in the application of section 80 automatically and immediately reduces the NCL balance for a taxation year because of the D.2 element of the NCL definition in subsection 111(8).

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