SUBJECT: Forgiven Interest
This is in reply to your memorandum of April 16, 1991, concerning the application of subsection 80(4) of the Act in a situation where section 79 applies.
You describe a situation where section 79 applies in respect of a debt. Accrued interest, which had previously been deducted in computing income, is forgiven. Since section 79 applies, paragraph 80(1)(e) of the Act precludes the application of subsection 80(1) to the debt. However, it is your view that subsection 80(4) would apply to deem the accrued interest to be a separate debt obligation to which subsection 80(1) would apply.
We agree that subsection 80(4) of the Act would apply to deem for purposes of subsection 80(1) that the interest payable is a principal amount equal to the amount that was deducted in computing income. Subsection 80(1) of the Act would apply in respect of this deemed principal amount. Paragraph 80(1)(e) of the Act would not apply as section 79 does not apply in respect of the accrued interest.
However, it has been suggested that section 79 of the Act applies where both the terms of the particular debt instrument and the general law of the province provide that unpaid interest is to be added to the principal amount and treated as principal (see The Canadian Tax Journal, vol. 33, p. 938)). In such cases the debtor may argue that section 79 applies as if the interest were part of the principal amount. The Department, however, has not accepted this position (see paragraphs 5 & 7 of IT-505).
We trust this will be of assistance to you.
for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch