Words and Phrases - "novation"


21 July 2009 Internal T.I. 2009-0322591I7 F - Déduction des intérêts

replacement of note and capitalized interest by new note with increased amount did not constitute payment by novation of the old debt

The taxpayer purchased assets from the vendor (apparently, a non-resident) in consideration for shares of the taxpayer and interest-bearing debt, that was evidenced by a note providing that unpaid interest could be added to the principal of the note. This was done, and a new note subsequently was issued for the amount of the original indebtedness plus the capitalized interest. Did this constitute a payment by novation?

After quoting from Quebec commentary that “[a]s a general rule, the mere delivery of a promissory note does not entail novation of the pre-existing obligation” and the “promissory bill is then considered as a simple means of acknowledging the debt,” CRA stated:

[T]he issuance of the note … did not constitute a payment and that there was no novation of the original debt by reason of the issuance of this second note.”

After quoting from Québec Cartier, CRA concluded that “the Taxpayer did not pay the increased and annually capitalized interest and did not credit the Vendor with such interest when the [new] note … was issued.”

Words and Phrases
Locations of other summaries Wordcount
Tax Topics - General Concepts - Payment & Receipt replacement of note with capitalized note with note for full amount did not constitute payment by novation 119
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Paragraph 212(1)(b) issuance of replacement promissory note for amount of previous principal plus capitalized interest was not a crediting of such interest 151

13 July 2018 Internal T.I. 2017-0713301I7 - Assumption of accrued interest

the covenant of the assuming debtor to pay accrued interest on a debt assumption was a payment in kind subject to Part XIII tax

The Partnership, a general partnership governed by the laws of a U.S. state that was a Canadian partnership under s. 102 as its partners were Canco and a wholly-owned Canadian sub of Canco, held all the shares of a U.S. LLC (the “Creditor Affiliate”), which had made an interest bearing loan to the Partnership (the “Loan”). The Loan was not recognized for U.S. tax purposes because Creditor Affiliate was a disregarded entity.

The Partnership subsequently transferred all of its assets, including the shares of the Creditor Affiliate, to a newly formed wholly-owned U.S. subsidiary of Partnership (the “Debtor Affiliate”), the consideration for which included the Debtor Affiliate assuming the Partnership’s liability to repay the Loan and to pay the accrued but unpaid interest thereon (the “Accrued Interest”) to the Creditor Affiliate. The Partnership was thereupon released of its obligations to the Creditor Affiliate by the Creditor Affiliate.

In response to a query as to whether Part XIII withholding tax applies to the Accrued Interest pursuant to paragraph 212(1)(b), the Directorate indicated its “preliminary conclusion” that there was a novation of the Partnership’s Loan obligation and then stated:

[A]t the time of this novation, the Partnership would be considered to have made a payment or credit in kind of the Accrued Interest to the Creditor Affiliate by delivering the Debtor Affiliate’s covenant to make the payments under the Loan agreement to the Creditor Affiliate.

After noting that s. 212(13.1)(a) deemed the Partnership to be a person resident in Canada respecting then kind payment of the Accrued Interest, it concluded:

[P]ursuant to paragraph 212(1)(b), the Creditor Affiliate would have an obligation to pay a tax of 25% on the amount of the Accrued Interest that was paid or credited to it in kind by the Partnership at the time the obligation to pay the Accrued Interest was assumed by the Debtor Affiliate as a result of the novation.

Words and Phrases
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(13.1) - Paragraph 212(13.1)(a) withholding when debt of Canadian partnership assumed by sub 171

Blank v Commissioner of Taxation, [2016] HCA 42

payments under profit-linked phantom units in affiliate were ordinary income when received

The taxpayer was employed by Glencore International AG (“GI”), an international commodity trading business incorporated in Switzerland, or a subsidiary from November 1991 to December 2006, with his employment in Australia commencing in 2002 when he also became an Australian resident. In 1994, GI granted him rights (Genusscheine, or “GS”) pursuant to an agreement with him and evidenced by profit sharing certificates issued pursuant to its articles of association, to share in future consolidated net income. At the same time, Glencore Holding AG (“GH”), the ultimate parent, issued shares to him for cash at their SF par value, with the shares being subject to a put in his favour, and a call in GH’s favour, exercisable, at a price equal to the par value, upon his termination of employment or certain other triggering events. The two agreements were “stapled,” i.e., the validity of each agreement was conditional on the execution of the other.

The original agreement for GSs was replaced at various junctures, including in 2005 by the “IPPA 2005” (described at para. 35 as a "novation," being "'simply a new contract standing in the place of the old'"), at which time the taxpayer was granted phantom units (Profit Participation Units, or “PPUs”) in GI for calculating his entitlement to the profit participation ultimately payable to him as deferred compensation (styled as “Incentive Profit Participation” or “IPP”) on the surrender of his rights. The PPUs were linked to GSs (in which the taxpayer had no interest) issued by GH to GI, which were to be repurchased by GH when his employment terminated. Under the IPPA 2005, his IPP became due 30 days after his termination of employment on December 31, 2006 and was payable in 20 instalments over five years (with interest). A proportion of each instalment was to be withheld and paid to the Swiss Federal Tax Administration ("the Swiss FTA") on account of Swiss withholding tax. Pursuant to a Declaration dated March 31, 2007, the taxpayer, in consideration for the “Amount” of US$160,033,328 and CHF 80,000, relinquished to GI his claims to the PPU and GS, and assigned all his GH shares to GH.

In finding that the Amount was income to the taxpayer under s. 6-5(1) of the Income Tax Assessment Act 1997, which provided that a person's "assessable income includes income according to ordinary concepts, which is called ordinary income," the Court stated (at paras 59, 61, and 63):

The terms of the IPPA 2005 expressly stated that the Amount was deferred compensation from Mr Blank's employment with Glencore Australia. … The Amount was paid as a lump sum as an additional reward to Mr Blank for the services he had performed for the Glencore Group. …

The IPPA 2005 also recorded that Mr Blank had no interest whatsoever in the GS and did not acquire any right in or title to any assets, funds or property of GI, Glencore AG or any other subsidiary. … [A] GS granted no more than a claim to a cumulative portion of the balance sheet profit, and that the claim was granted not upon the issue or allocation of the GS to the employee but upon restitution of the GS at the time the employment ceased. …

The fact that the Amount was paid after the termination of the contract of service, by a person other than the employer (here, GI) and separately to ordinary wages, salary or bonuses, does not detract from its characterisation as income if the payment is, as here, a recognised incident of the employment.

Words and Phrases

General Electric Capital Equipment Finance Inc. v. Canada, 2002 DTC 6734, 2001 FCA 392

changes to 3 of the 4 fundamental attributes of debt produced new debt

Following assessments of withholding tax on interest on notes owing by the taxpayer, the notes were amended to decrease the principal owing (by the amount of withholding tax paid by the taxpayer on behalf of the non-resident holder), increase the interest rate (by grossing-up the interest rate for the applicable withholding tax), extend the maturity date by one year and change the identity of the payee (to reflect the notes' assignment) were found to give rise to new obligations, with the result that their maturity date occurred within five years of the date of (new) issue. (The new non-resident holder of the notes was considered to deal with the taxpayer at arm's length.)

Sexton JA stated (at para. 10) that "I ... do not think that a novation is required before there can be a new obligation" and (at para. 12) "because novation is an issue of fact, whether or not a new obligation has been created is also, by analogy, a question of fact," and noted (at para. 13) that in Wiebe "this Court held that fundamental changes to a stock option agreement which substantially affected the basic elements of the agreement were inconsistent with the continued existence of that agreement." He concluded (at paras. 14-16):

The fundamental terms of the promissory notes in question were

  1. ...the identity of the debtor;
  2. ...the principal amount of the note;
  3. ...the amount of interest under the note; and
  4. ...the maturity date of the note.

….In the present case, all but one of these fundamental terms were changed.

….When it can be said that substantial changes have been made to the fundamental terms of an obligation which materially alter the terms of that obligation, then a new obligation is created ... .

Words and Phrases
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 212 - Subsection 212(1) - Subparagraph 212(1)(b)(vii) material changes produced new obligation 183

National Trust Co. v. Mead, [1990] 5 WWR 455, [1990] 2 S.C.R. 410

assumption of loan did not entail its novation

The execution by an individual ("Mead") of an assumption of liability agreement in favour of a mortgage lender ("National Trust"), with Mead thereby being acepted by National Trust as the principal debtor, was found not to entail the novation of the mortgage loan in light inter alia of a clause in the original mortgage which provided that no "dealing by the Mortgagee with the owner of the equity of redemption of the Mortgage Premises shall in any way affect or prejudice the rights of the Mortgagee against the Mortgagor ... for the payment of the money secured by this Mortgage." Before so concluding, Wilson J. referred with approval to Canada Permanent Trust Co. v. Neumann (1986), 8 B.C.L.R. (2d) 318 (C.A.), where the following four elements necessary to establish a novation were stipulated:

  1. The new debtor must assume the complete liability.
  2. The creditor must accept the new debtor as a principal debtor and not as an agent or guarantor.
  3. The creditor must accept the new contract in full satisfaction and substitution for the old contract.
  4. The new contract must be made with the consent of the old debtor.
Words and Phrases
Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 80 - Subsection 80(1) tests for novation 151

Carma Developers Ltd. v. The Queen, 96 DTC 1798, [1996] 3 CTC 2029 (TCC), briefly aff'd 96 DTC 6569 (FCA)

Under a plan that was approved by the requisite majority of creditors in accordance with the companies' Creditors Arrangement Act, various classes of unsecured or undersecured creditors of the taxpayer ("CDL") transferred indebtedness of the taxpayer in exchange for shares of the taxpayer's parent corporation ("CL").

Bowman TCJ. found that the debts were not extinguished by novation notwithstanding that the creditors acknowledged to CDL that no further consideration was owed to them in respect of the assigned indebtedness, and stated (at p. 1802):

"A novation involves the creation of a new contractual relationship, generally where a debtor is released from its obligation to an obligee with the consent of the obligee and the assumption of the obligation by a third party so that a new obligation arises between the obligee and the third party. Here there is no new contract. The same debt of CDL continues to exist."

He also found that the debts had not been settled, and stated (at p. 1802):

"'Settle' connotes a final and legal resolution of a taxpayer's obligation whereby that obligation is reduced or brought to an end."

Words and Phrases
extinguish settle novation