A small business corporation with nominal accumulated profits purchased for cancellation shares in its capital having nominal capital in consideration for the issuance by it of interest-bearing debt. After indicating that the indirect use test also extended to s. 20(1)(c)(ii), so that interest on the debt would be deductible to the extent of the capital of the repurchased shares, and the accumulated profits, that had been used in the corporation’s business, CRA stated, in response to the proposition that the debt forgiveness rules would not apply because the debt was not a commercial debt obligation:
Where only a portion of the debt obligation replaces eligible capital, as would be the case in the Particular Situation, it is our view that the amount that may be deducted as interest expense on the debt obligation is limited to the interest expense relating to that portion of the debt obligation.
… [T]he settlement of the Debt for an amount less than its principal amount would trigger the application of section 80 if the Debt qualified as a "commercial debt obligation" and "commercial obligation". … [T]he Debt would qualify as a "commercial debt obligation" and "commercial obligation" if an amount in respect of interest on the Debt is deductible in computing Opco's income if such interest was paid or payable, or would have been had it been paid or payable, by the debtor in respect of it pursuant to a legal obligation.