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 the debt forgiveness rules apply to a particular debt?
Reasons: Depends on the facts.
Author: Friedlander, Lara G.
Section: 40(2)(g)(ii), 61.3(1), "commercial obligation" and "commercial debt obligaton" in 80(1), 80(2)(a), 80(13), "bankrupt" in 248(1) and section 2 of Bankruptcy and Insolvency Act
November 21, 2014
Re: Intercompany debt
This is in response to your email of June 9, 2014 concerning the treatment of certain intercompany debt.
You have indicated that Mr. X, a resident of Canada, was the sole shareholder of Corporation A and Corporation B. Corporation A was an operating company; Corporation B was a type of holding company. Corporation A owed various amounts (the “Debt”) on capital account to Corporation B. Mr. X passed away and all operations of both Corporation A and Corporation B ceased. Corporation A has no assets and has no ability to repay the Debt. Corporation B, which holds the Debt on capital account, intends to write off the Debt. You have indicated that steps may be taken that would result in the settlement or extinguishment of the Debt. You have asked for our general comments regarding the possible application of the debt forgiveness rules to the Debt as well as certain other general comments.
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.
Generally, the debt forgiveness rules apply only when there has been a settlement of a commercial obligation. “Commercial obligation” of a debtor is defined in subsection 80(1) to mean a “commercial debt obligation” or a “distress preferred share” issued by the debtor. Generally, a “commercial debt obligation” of a debtor is defined in subsection 80(1) to mean a debt obligation issued by a debtor where interest that was paid or payable by the debtor in respect of it pursuant to a legal obligation was deductible by the debtor or would have been deductible had interest been paid or payable by the debtor in respect of it pursuant to a legal 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,  3 C.T.C. 2029 (T.C.C.), affirmed at  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 court case of The Queen v. Diversified Holdings Ltd.,  2 C.T.C. 263 (F.C.A.) (leave to appeal to S.C.C. denied) also dealt similarly with this issue.
If the Debt is settled finally and legally, then Corporation A may be subject to the debt forgiveness rules under section 80 to the extent that the Debt has not been repaid. Whether the debt forgiveness rules result in any income inclusion to Corporation A will depend on a number of factors such as the tax attributes of Corporation A.
If the Debt is settled and an amount is included in Corporation A’s income under subsection 80(13) of the Act because of debt forgiveness, a full or partial offsetting deduction under subsection 61.3(1) of the Act may be available. Generally, where the debtor is a corporation resident in Canada, the amount of the deduction is calculated under a formula set out in subsection 61.3(1) of the Act. In addition, no income inclusion for Corporation A would arise from the debt forgiveness if Corporation A is “bankrupt” at the time of the settlement as a result of paragraph (i) of the definition of “forgiven amount” in subsection 80(1) of the Act. “Bankrupt” is defined in subsection 248(1) of the Act as having the meaning assigned by the Bankruptcy and Insolvency Act (Canada). We refer you to Interpretation Bulletin IT-239R dated July 16, 1979, for further general comments on the debt forgiveness regime in sections 80 to 80.04 of the Act.
If the Debt is settled finally and legally such that it is disposed of by Corporation B, then Corporation B may be entitled to claim a loss on the disposition of the Debt subject to the application of various stop-loss rules such as subparagraph 40(2)(g)(ii) of the Act. Otherwise, generally, Corporation B will not be entitled to claim a loss unless the Debt is established to be a bad debt at the end of a taxation year and Corporation B makes an election under subsection 50(1) of the Act. Whether such a loss is allowable depends on the application of various stop-loss rules.
We trust that these comments will be of assistance.
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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