2016-0628741I7 Interaction of s. 80 and s. 143.4

Principal Issues: 1. Whether a taxpayer's contingent right to reduce "Interest Debt" under a XXXXXXXXXX (the “Plan”) pursuant to XXXXXXXXXX, where the Plan was approved by XXXXXXXXXX, would result in the application of section 80 of the Act or would subsection 143.4(4) of the Act apply instead?

Position: Subsection 143.4(4) would apply.

Reasons: In order for section 80 to apply, the debt obligation must be "settled." In this case, the obligation is not settled because a number of conditions precedent set out in the Plan were not met by the end of XXXXXXXXXX. However, the right to reduce the Interest Debt would be considered a "right to reduce" since it may reasonably be concluded at the end of XXXXXXXXXX, having regard to the circumstances, that the right to reduce would become exercisable.

Author: Gibbons, Jim
Section: section 80; section 143.4; paragraph 20(1)(c)

                                                                                                                                           May 26, 2016

XXXXXXXXXX                                                                                                                   HEADQUARTERS
XXXXXXXXXX TSO                                                                                                           J. Gibbons

Attention:  XXXXXXXXXX                                                                                                   2016-062874

XXXXXXXXXX (the “Taxpayer”)

This is in reply to your email dated January 20, 2016, concerning the interaction of sections 80 and 143.4 of the Income Tax Act (the “Act”).  In particular, you have asked whether, in the specific circumstances detailed below, subsection 143.4(4) of the Act would apply rather than subsection 80(2) for the Taxpayer’s taxation year ending in XXXXXXXXXX.

FACTS

1. In XXXXXXXXXX, XXXXXXXXXX (the “Taxpayer”) borrowed funds (the “Notes”) on an interest-bearing basis for the purposes of earning income.  The lenders are referred to as the “Noteholders,” which is the term used in the XXXXXXXXXX (the “Plan”) described below.

2. The Taxpayer had a legal obligation to pay interest (the “Interest Expense”) on the Notes for each taxation year in which the Notes were outstanding.

3. From XXXXXXXXXX to XXXXXXXXXX, most of the Interest Expense was not paid by the end of each such taxation year in which it was payable.  Accordingly, at the end of XXXXXXXXXX, the Taxpayer had a total amount of Interest Expense owing to the Noteholders (the “Interest Debt”) of $XXXXXXXXXX (hereinafter rounded to $XXXXXXXXXX).

4. For the most part, the Taxpayer did not deduct the Interest Expense in the taxation years in which it was incurred.  Accordingly, at the end of XXXXXXXXXX, the Taxpayer had a total amount of $XXXXXXXXXX (hereinafter rounded to $XXXXXXXXXX) of unclaimed Interest Expense (the “Unclaimed Interest Expense”).

5. On XXXXXXXXXX, Taxpayer XXXXXXXXXX.

6. On XXXXXXXXXX, the Plan was submitted and subsequently accepted by the Noteholders and the XXXXXXXXXX.

7. In its tax return for the XXXXXXXXXX taxation year, the Taxpayer added $XXXXXXXXXX to its non-capital losses at the beginning of the year to take into account the Unclaimed Interest Expense.

8. The Taxpayer’s XXXXXXXXXX taxation year is statute barred but the Taxpayer signed a waiver for the XXXXXXXXXX and XXXXXXXXXX taxation years.

9. The Taxpayer deducted $XXXXXXXXXX (XXXXXXXXXX) from its balance of non-capital losses carried forward to XXXXXXXXXX on the basis that it had a “forgiven amount” pursuant to section 80 of the Act in respect of the Interest Debt.  The Taxpayer calculated the forgiven amount as the difference between the Interest Debt minus the total fair market value (“FMV”) of its assets (XXXXXXXXXX).

YOUR QUESTIONS

1. Do the debt forgiveness rules in subsection 80(2) apply in XXXXXXXXXX when the Plan is approved by the Noteholders and XXXXXXXXXX?

2. Does the Plan result in the application of subsection 143.4(4)?

OUR VIEWS

Paragraph 20(1)(c) of the Act allows a taxpayer to deduct simple interest paid or payable in the year on borrowed money used by the taxpayer for the purpose of earning income from a business or property. Specifically, subparagraph 20(1)(c)(i) refers to “an amount paid in the year or payable in respect of the year (depending on the method regularly followed by the taxpayer in computing the taxpayer's income), pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy)”. It is a question of fact whether borrowed money is used for the purpose of earning income from a business or property.

Pursuant to paragraph 20(1)(c)(i) of the Act, the Taxpayer may only deduct interest paid in the year or payable in respect of the year pursuant to a legal obligation to pay interest on borrowed money used for the purpose of earning income from a business or property, for that particular taxation year.  Therefore, the Taxpayer cannot deduct the total Unclaimed Interest Expense that was incurred from the XXXXXXXXXX to XXXXXXXXXX taxation years in the XXXXXXXXXX taxation year.  However, it is our understanding that the taxpayer can request adjustments in respect of the unclaimed interest deductions for each of the XXXXXXXXXX to XXXXXXXXXX years as there are non-capital losses in those years.

1. Debt Forgiveness

As indicated above, the Taxpayer deducted $XXXXXXXXXX from its balance of non-capital losses carried forward to XXXXXXXXXX on the basis that it had a “forgiven amount” pursuant to section 80 of the Act in respect of the Interest Debt.  The Taxpayer calculated the forgiven amount as the difference between the Interest Debt minus the total fair market value of its assets. You have asked whether subsection 80(2) applies in XXXXXXXXXX when the Plan is approved by the Noteholders and the XXXXXXXXXX.

Subsection 80(2) of the Act provides, inter alia, as follows: 

Application of debt forgiveness rules — For the purposes of this section,

 (a) an obligation issued by a debtor is settled at any time where the obligation is settled or extinguished at that time (otherwise than by way of a bequest or inheritance or as consideration for the issue of a share described in paragraph (b) of the definition "excluded security" in subsection (1));

 (b) an amount of interest payable by a debtor in respect of an obligation issued by the debtor shall be deemed to be an obligation issued by the debtor that

(i) has a principal amount, and

(ii) was issued by the debtor for an amount,

equal to the portion of the amount of such interest that was deductible or would, but for subsection 18(2) or (3.1) or section 21, have been deductible in computing the debtor's income for a taxation year;

 (c) subsections (3) to (5) and (7) to (13) apply in numerical order to the forgiven amount in respect of a commercial obligation;

"excluded security" in subsection (1)).”

At the 2010 Canada Revenue Agency (“CRA”) Roundtable, the CRA stated that the time at which an obligation is settled within the meaning of paragraph 80(2)(a) is a mixed question of fact and law and cannot be determined without an examination of all the circumstances of a given situation.  In this case, the Plan indicates that the purpose of the Plan is as follows:

XXXXXXXXXX

Based on the information provided, it is our view that the Notes, including the Interest Debt, will be settled on the Plan Implementation Date and be replaced with rights to Interest Distributions.  The Plan Implementation Date is defined under the Plan as follows:

XXXXXXXXXX

Based on our understanding that the Conditions Precedent were not fulfilled by the end of XXXXXXXXXX, and the Plan Implementation Date did not occur in that taxation year, it is our view that the debt was not settled in XXXXXXXXXX, and therefore, subsection 80(2) does not apply in XXXXXXXXXX.

2. Subsequent contingent amount

You have also asked whether the Plan results in the application of subsection 143.4(4).

Subsection 143.4(4) provides as follows:

(4) Subsequent years — Subject to subsection (6), if at any time in a taxation year that is after a taxation year in which an expenditure of the taxpayer occurred, the taxpayer, or another taxpayer not dealing at arm's length with the taxpayer, has a right to reduce an amount in respect of the expenditure (in this subsection and subsection (5) referred to as the "prior expenditure") that would, if the taxpayer or the other taxpayer had had the right to reduce in a particular taxation year that ended before the time, have resulted in subsection (2) applying in the particular taxation year to reduce or eliminate the amount of the prior expenditure, the taxpayer's subsequent contingent amount in respect of the prior expenditure, as determined under subsection (5), is deemed, to the extent subsection (2) and this subsection have not previously applied in respect of the expenditure,

 (a) to be an amount received by the taxpayer at the time in the course of earning income from a business or property from a person described in subparagraph 12(1)(x)(i); and

 (b) to be an amount referred to in subparagraph 12(1)(x)(iv).

A “right to reduce” is defined in subsection 143.4(1) as follows:

“right to reduce” means a right to reduce or eliminate an amount in respect of an expenditure at any time, including, for greater certainty, a right to reduce that is contingent upon the occurrence of an event, or in any other way contingent, if it is reasonable to conclude, having regard to all the circumstances, that the right will become exercisable.

Notwithstanding that the 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, it may still fall under the definition of a “right to reduce” in subsection 143.4(1) “if it is reasonable to conclude, having regard to all the circumstances, that the right will become exercisable.”  [My emphasis.]  Since there is no definition in the Act of the term “exercisable,” we refer to the ordinary meaning of this term.  According to Merriam-Webster’s online dictionary, the verb to “exercise” includes the following meanings:

1 a :  to make effective in action :  use <didn't exercise good judgment>

b :  to bring to bear :  exert <exercise influence>

c :  to implement the terms of (as an option)

Also, according to this online dictionary, the suffix “able” means:

* : fit for or worthy of being

* : likely to or capable of

* : having a certain quality

Based on the foregoing definitions, a right that is “exercisable” may be interpreted as a right that is “capable of being made effective in action,” “capable of being brought to bear” or “capable of being implemented.”  Thus, a right may be considered a “right to reduce,” if it is reasonable to conclude, having regard to all the circumstances, that the right will become “capable of being made effective in action” or “capable of being implemented.”

Taxpayer’s Representations:

The Taxpayer’s representatives have argued that for a right to be “exercisable,” the taxpayer must have a positive right to reduce an amount.  Accordingly, they have argued that automatic reductions or reductions that are beyond the control of the taxpayer would not be caught under the definition of a “right to reduce.”

XXXXXXXXXX

Conclusion

It is our view, based on the information provided, that the 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 that it 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.  Thus, subsection 143.4(4) would apply in XXXXXXXXXX and this will result in an income inclusion for that year pursuant to paragraph 12(1)(x). Any income inclusion pursuant to paragraph 12(1)(x) should be offset by losses generated by the unclaimed interest expense relating to the XXXXXXXXXX to XXXXXXXXXX taxation years.

Further, even if the Interest Debt is settled in a subsequent year, there should be no double taxation since section 80 will not apply.  Paragraph 80(2)(b) provides that an amount of interest payable by a debtor in respect of an obligation issued by a debtor is deemed to be an obligation issued by the debtor that has a principal amount.  Subparagraph (a)(i) of the definition of “excluded obligation” in subsection 80(1) includes an obligation where the proceeds from the issue of the obligation were included in computing the debtor’s income in paragraph 12(1)(x).  In this regard, paragraph (j) of the definition of “forgiven amount” in subsection 80(1) carves out the portion of the principal amount of the obligation that represents the principal amount of an “excluded obligation.”

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. A severed copy will also be distributed to the commercial tax publishers, following a 90-day waiting period (unless advised otherwise to extend this waiting period), for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity.  Requests for this latter version should be e-mailed to: LPRA-PLAR ITR-DDI Access Team-Équipe d'Accès. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust that these comments will be of assistance.

G. Moore
for Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate

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