Principal Issues: [TaxInterpretations translation] In a particular situation where a corporation purchase for cancellation shares of its capital stock held by another corporation in exchange for a debt, would the settlement of the debt for an amount less than its principal amount engage section 80?
Position: General Comments.
Reasons: Section 80 would apply if the debt qualified as a "commercial obligation" and a "commercial debt obligation".
XXXXXXXXXX 2008-029390
Guy Goulet CA, M. Fisc.
January 12, 2009
Dear Sir,
Subject: Section 80 of the Act
This is in response to your letter of September 2, 2008 in which you requested our comments on the application of section 80 in the Particular Situation described below.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
Particular Situation
This is a situation where an individual holding shares of the capital stock of a small business corporation (“Opco”) disposed of a certain number of shares of the capital stock of that corporation to his former spouse in settlement of rights arising out of their marriage. Immediately thereafter, the former spouse transferred those shares to a newly incorporated corporation (“Newco”). Finally, Opco proceeded with the purchase for cancellation of shares of its capital stock held by Newco in consideration for an interest-bearing debt (the “Debt”).
You are of the opinion that, assuming that the capital (contributed capital or accumulated profits) regarding the shares purchased for cancellation was nominal, a settlement of the Debt for an amount less than its principal amount would not engage the application of section 80. In your view, the Debt would not be a "commercial obligation" or a "commercial debt obligation" and that the settlement of the Debt would not result in a "forgiven amount" as defined in subsection 80(1).
Our Comments
It appears to us that the situation described in your letter could constitute an actual situation involving taxpayers. The Canada Revenue Agency ("CRA") does not generally provide written opinions on proposed transactions otherwise than by way of advance income tax rulings. Furthermore, it is up to the relevant Tax Services Office to determine whether completed transactions have received appropriate tax treatment. We can, however, offer the following general comments which may not apply in full in a particular situation.
Section 80 provides for certain rules for a settlement of a commercial obligation. The definition of "commercial obligation" in subsection 80(1) indicates that a commercial debt obligation issued by a debtor is a commercial obligation. Subsection 80(1) defines "commercial debt obligation" as a debt obligation issued by the debtor on which an amount in respect of interest is deductible, inter alia, in computing the debtor's income without reference to certain provisions of the Act if the interest was paid or payable, or had been paid or payable, by the debtor pursuant to a legal obligation.
Subparagraph 20(1)(c)(ii) permits a deduction in computing income for a taxation year of interest 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 an amount payable for property acquired for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy) that is wholly applicable to that source of income, or the part of the interest that may reasonably be regarded as applicable thereto.
As discussed in ¶ 29 of IT-533 Interest Deductibility and Related Issues, it is our view that where a note is issued to purchase and cancel (or otherwise redeem) shares, interest expense may be deductible under subparagraph 20(1)(c)(ii) to the extent of the interest on the amount of the note issued that is within the limits described in ¶ 23 of IT-533. That paragraph outlines our position regarding the direct use test for borrowed money used to redeem shares. It is our view that in the case of a share redemption, borrowed money used to replace eligible capital (contributed capital for the redeemed shares and/or profits accumulated before the redemption) of a corporation that was used for purposes that would have qualified for interest deductibility had the capital been borrowed may constitute an exception to the direct use test.
Consequently, it is our view that where a debt obligation is issued to purchase and cancel or redeem shares, an amount in respect of interest expense on the debt obligation may be deductible by virtue of subparagraph 20(1)(c)(ii) to the extent that the amount of the debt obligation replaces the eligible capital of the corporation. 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.
It is difficult for us to comment on the situation that you have submitted to us as we do not have all the relevant facts and circumstances surrounding the transactions described in your application. However, we are of the view that the 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". Also, we are of the view that the 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.
We hope that our comments are of assistance.
Best regards,
Ghislain Martineau
Manager
Financial Sector and Exempt Entities Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.