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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
Whether predecessor losses available to Amalco for debt forgiveness rules
Position: Yes
Reasons: Interaction of sections of ITA
2002-017825
XXXXXXXXXX Denise Dalphy, LL.B.
(613) 941-1722
June 17, 2003
Dear XXXXXXXXXX:
Re: Treatment of Debtor under Section 80
We are writing in reply to your letter dated December 10, 2002 wherein you requested a technical interpretation with regard to the treatment of a debtor under section 80 of the Income Tax Act (the "Act") on the settlement of a debt obligation by a corporation that was formed on an amalgamation to which section 87 of the Act applied after the control of the predecessor parent was acquired by a third party.
Our understanding of the hypothetical fact situation is as follows:
1. Canco #1 and Canco #2 are each taxable Canadian corporations for the purposes of the Act. The taxation year of each corporation occurs at the end of the calendar year.
2. Canco #1 owns all of the shares of Canco #2.
3. Canco #2 has an undeducted non-capital loss and an undeducted net capital loss. Canco #2 has debt owing (the "Relevant Debt") to an arm's length party (the "Creditor"). The undeducted loss carryforwards are referred to below as the "Relevant Tax Attributes". The Relevant Debt is a "commercial debt obligation", as defined in subsection 80(1) of the Act. The Relevant Debt was not issued in contemplation of the acquisition of control referred to in the following paragraph.
4. In a subsequent taxation year there is an acquisition of control of Canco #1 and Canco #2 by reason of an acquisition of control of all of the shares of Canco #1. At the same time, there is an amalgamation of Canco #1 and Canco #2 to form a new corporation ("Amalco"). The loss carryforwards were not deducted in computing Canco #2's taxable income for its previous taxation year.
5. On the day afer the amalgamation, the Relevant Debt (now owing by Amalco) is replaced by new debt (the "New Debt") owing by Amalco in circumstances to which paragraph 80(2)(h) of the Act applies. The only consideration given by Amalco to the Creditor for the settlement of the Relevant Debt was the New Debt. The principal amount of the New Debt is equal to the principal amount of the Relevant Debt.
6. Later, in the same year, the New Debt is settled. As a consequence of the settlement of the New Debt, there is a "forgiven amount" determined under subsection 80(1) of the Act (the "Forgiven Amount")
Written confirmation of the consequences inherent in particular transactions are given by this directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5. Nonetheless, we shall provide some comments of a very general nature.
Please note that we have not considered the impact of the transactions in paragraph 5 since there is no evidence that this is a common situation or one that could have an impact on a number of taxpayers. Further, it is our understanding that the transactions described in your letter are actually proposed, and, as such, should you desire certainty, they should be the subject of an advance income tax ruling request where we would have an opportunity to analyze all of the facts and relevant documentation. In addition, we have restricted our comments of losses to non-capital losses, although a similar process of analysis would apply with respect to net-capital losses.
Acquisition Of Control
On the acquisition of control of Canco #1 and Canco #2 the rules in, inter alia, subsection 111(5) of the Act will apply to limit the ability of Canco #2 to deduct, inter alia, its pre-acquisition of control non-capital losses under paragraph 111(1)(a) of the Act (in general terms, the same business must be carried on). The non-capital losses of Canco #2 would remain "non-capital losses" of Canco #2 within the meaning of that term as defined in subsection 111(8) of the Act, although its ability to deduct them may be limited.
Amalgamation
On the amalgamation of Canco #1 and Canco #2, the rule in paragraph 87(2.1)(a) of the Act will apply to deem Amalco to be the same corporation as Canco #2 for the purpose of determining Amalco's non-capital losses. However, the deeming rule is a limited one, and it does not apply, inter alia, with respect to the determination of the income of Amalco.
That is, the deeming rule in paragraph 87(2.1)(a) of the Act (which is a rule in Division B of the Act, the part of the Act that contains the rules with respect to the computation of "income") will not apply to the computation of Amalco's Division B income, but will apply with respect to the computation of Amalco's "taxable income" (Division D). Consequently, for the purposes of Division D and the determination of the quantum of Amalco's "non-capital losses" (as defined in Division D), Amalco is deemed to be the same corporation as Canco #2. The limitations in subsection 111(5) of the Act would apply to any subsequent use of the losses by Amalco.
Subsection 87(7) of the Act would also apply on the amalgamation. It provides, inter alia, that the provisions of the Act shall apply as if Amalco "issued or incurred" the pre-amalgamation debts of Canco #2 "at the time [the debts of Canco #2] were incurred or issued by [Canco #2] under the agreement made on the day on which [Canco #2] made an agreement under which the debt[s] ... was issued". The impact of the deeming rule in subsection 87(7) of the Act is not limited and it applies, not only Amalco's Division D computations, but also to, inter alia, its Division B computations.
Settlement of Debt
The relevant section of the Act is subsection 80(3), which provides:
"(3) Reductions of non-capital losses - Where a commercial obligation issued by a debtor is settled at any time, the forgiven amount at that time in respect of the obligation shall be applied to reduce at that time, in the following order,
(a) the debtor's non-capital loss for each taxation year that ended before that time to the extent that the amount so applied
(i) does not exceed the amount (in subsection (4) referred to as the debtor's "ordinary non-capital loss at that time for the year") that would be the relevant loss balance at that time for the obligation and in respect of the debtor's non-capital loss for the year if the description of E in the definition "non-capital loss" in subsection 111(8) were read without reference to the expression "the taxpayer's allowable business investment loss for the year", and
(ii) does not, because of this subsection, reduce the debtor's non-capital loss for a preceding taxation year; ..."
1. "Where a commercial obligation issued by debtor..." [Amalco]
In this case, we have assumed that the debt is a commercial obligation. Pursuant to subsection 87(7) of the Act, the obligation was issued by Amalco - Amalco is deemed to have incurred or issued the debt at the time it was incurred or issued by Canco #2 and under the agreement made by Canco #2.
2. "... is settled at any time,"
In this case, the debt is actually settled subsequent to the amalgamation.
3. "... the forgiven amount at that time in respect of the obligation"
Paragraph 87(2)(h.1) of the Act provides that as a consequence of the amalgamation of Canco #1 and Canco #2 to form Amalco, for the purposes, inter alia, the definition of "forgiven amount" in subsection 80(1) of the Act, Amalco is deemed to be the same corporation as Canco #2.
In addition, "[F]orgiven amount" is defined as follows in subsection 80(1) of the Act:
"forgiven amount" at any time in respect of a commercial obligation issued by a debtor is the amount determined by the formula:
A-B
where
A is the lesser of the amount for which the obligation was issued and the principal amount of the obligation
and
B is the total of
(a) the amount, if any, paid at that time in satisfaction of the principal amount of the obligation, ..."
As such, pursuant to subsection 87(7) of the Act and paragraph 87(2)(h.1) of the Act, which apply for purposes of, inter alia, the definition of "forgiven amount" in 80(1) of the Act, both deem Amalco to be the same corporation as its predecessor.
4. "shall be applied to reduce at that time, in the following order"
"(a) the debtor's non-capital loss for each taxation year that ended before ..."
Although paragraph 87(2.1)(a) of the Act is a limited deeming rule, it does provide that for certain purposes, including computing Amalco's taxable income under Division D, that Canco #2's non-capital losses are Amalco's non-capital losses. Further, although the rules in subsection 80(3) of the Act and paragraph 87(2.1)(a) of the Act are in Division B, not Division D, they do apply to the computation of Amalco's taxable income in Division D, which includes a determination of whether Amalco has "non-capital losses" as defined in subsection 111(8) of the Act. As such, paragraph 87(2.1)(a) of the Act applies to subsection 80(3) of the Act because subsection 80(3) does not involve a determination of Amalco's income; instead it involves the computation of Amalco's taxable income, and in particular the amount of its non-capital losses as determined under subsection 111(8) of the Act.
5. "...relevant loss balance at that time for the obligation and in respect of the debtor's non-capital loss for the year ..."
The definition of "relevant loss balance", which is contained in subsection 80(1) of the Act, describes how this amount is determined. It also provides that the "relevant loss balance" with respect to losses incurred in years prior to an acquisition of control are deemed to be nil unless:
"(d) the obligation was issued by the debtor before, and not in contemplation of, the acquisition of control, or
(e) all or substantially all of the proceeds from the issue of the obligation were used to satisfy the principal amount of another obligation to which paragraph (d) or this paragraph would apply if the other obligation were still outstanding;"
The effect of the "relevant loss balance" provision is that it may reduce a debtor's non-capital losses, as defined in subsection 111(8) of the Act, such that they are not available to be deducted under paragraph 111(1)(a) of the Act.
As discussed earlier, the deeming rule in subsection 87(7) of the Act would apply to deem Amalco to have "issued or incurred" the pre-amalgamation debts of Canco #2 "at the time the [debts of Canco #2] were incurred or issued by [Canco #2] under the agreement made on the day on which [Canco #2] made an agreement under which the debt[s] ... was issued". The result would be that unless the effect was overridden by section 245 of the Act, paragraph (d) of the definition of "relevant loss balance" would have application such that the losses of Canco #2 and then Amalco would not be deemed to be nil. As stated above, we would be pleased to consider the effect of paragraph 80(2)(h) of the Act in the context of request for an advance income tax ruling.
80(13) Income Inclusion
If the provisions of section 80 of the Act have applied to grind all losses of Amalco but there is still a forgiven amount, the question of the application of 80(13) of the Act arises.
Subsection 80(13) of the Act states:
"(13) Income inclusion - Where a commercial obligation issued by a debtor is settled at any time in a taxation year, there shall be added, in computing the debtor's income for the year from the source in connection with which the obligation was issued, the amount determined by the formula
(A + B - C - D) × E
where
A is the remaining unapplied portion of the forgiven amount at that time in respect of the obligation,
Paragraph 87(2.1)(a) of the Act does not apply to the computation of Amalco's income. As such, this deeming rule would not apply for the purposes of subsection 80(13) of the Act.
However subsection 87(7) of the Act, which applies for the entire Act, would apply. Subsection 87(7) of the Act provides, inter alia, that the provisions of the Act shall apply as if Amalco "issued or incurred" the pre-amalgamation debts of Canco #2 "at the time [the debts of Canco #2] were incurred or issued by [Canco #2] under the agreement made on the day on which [Canco #2] made an agreement under which the debt[s] ... was issued". The result is that subsection 87(7) of the Act would apply to subsection 80(13) of the Act to deem the debt obligation to have been issued by Amalco. In addition, paragraph 87(2)(h.1) of the Act provides that as a consequence of the amalgamation of Canco #1 and Canco #2 to form Amalco, for the purposes, inter alia, the definition of "forgiven amount" in subsection 80(1) of the Act, Amalco is deemed to be the same corporation as Canco #2. As such, the reference to the forgiven amount in variable A of the definition of "forgiven amount" in subsection 80(1) of the Act and as used in subsection 80(13) of the Act is a reference to Amalco's forgiven amount. The end result is that 80(13) of the Act could apply to Amalco.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Customs and Revenue Agency. Our practice is to make this specific disclaimer in all instances in which we provide an opinion.
Yours truly,
Steve Tevlin
Manager
Corporate Financing Section
Financial Industries Division
Income Tax Rulings Directorate
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