Principal Issues: Will an estate recognize a capital loss on the forgiveness of debt on the death of the testator?
Position: Question of fact as to the nature of the debt; but the creditor may incur a loss on the forgiveness of debt, the loss would be generally subject to the stop loss rules in subparagraph 40(2)(g)(ii)
Reasons: general comments and positions discussed
STEP CRA Roundtable – June 2012
QUESTION 3
Where indebtedness is forgiven by Will, a loss could result for the creditor.
Assuming this loss would otherwise meet the requirements for a capital loss (where the indebtedness was interest-bearing) and assuming the terms of the Will provide for a forgiveness of this debt, can the loss be considered a capital loss of the estate?
CRA Response
Where indebtedness is forgiven by Will, certain questions of law may arise as to the nature of the forgiveness and the timing of the extinguishment of the debt. For example, there may be circumstances in which the wording of a particular testamentary instrument leads to a conclusion at law that the indebtedness would be extinguished at death such that it never becomes a capital property of the estate. As such, the issue of a capital loss to the estate in those circumstances would never arise.
That said, however, for purposes of our response, we will assume that an estate holds indebtedness as a capital property that is subsequently forgiven pursuant to the terms of the Will.
The CRA has opined in the past that when indebtedness is forgiven, it would generally be considered a disposition to the creditor and if the debt is determined to be on account of capital, a capital loss may be incurred.
This loss may be denied pursuant to subparagraph 40(2)(g)(ii) of the Act unless the debt had been (i) acquired by the taxpayer for the purpose of gaining or producing income from a business or property (other than exempt income); or (ii) acquired as consideration for the disposition of capital property in an arm's length transaction. Where indebtedness is forgiven by Will, we are of the view that the stop loss rule in subparagraph 40(2)(g)(ii) would generally apply to deem the loss to be nil; however, this is ultimately a question of fact which would depend on the details of the particular debt forgiveness and the terms and conditions expressed in the testamentary instrument itself.
Kim Duval
2012-044295