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A.A. Cameron (613)957-2121
April 9, 1987
Dear Sirs:
Re: Request for a technical interpretation concerning the provisions of subsection 85(4) of the Income Tax Act
We are writing in response to your letter of January 19, 1987, in which you requested our views regarding the application of the above-noted provision of the Act to a situation outlined therein.
You have asked us to confirm that subsection 85(4) of the Act is applicable, in the circumstances described in your letter, to the effect that the parent company may add any loss sustained by it on the conversion of its debt, to the adjusted cost base of the preferred shares which it held in the capital stock of its subsidiary immediately after the debt conversion in accordance with the rules described in that subsection of the Act.
Alternatively you have asked if a loss arising on the conversion of the debt by the parent company would be a capital loss which is not deemed to be nil pursuant to subparagraph 40(2)(g)(ii) of the Act, notwithstanding that the debt was non-interest bearing, since the advances by it to the subsidiary were made to enable that subsidiary to pay dividends to the parent, and therefore, it could be reasonably concluded, on the recent authority of Business Art Inc. v. M.N.R. 86 DTC 1842 at page 1848, that the loans by the parent to the subsidiary were made for the purpose of gaining or producing income.
The situation which you have outlined in your above-mentioned letter would appear to relate to a particular taxpayer and, therefore, we are unable to comment specifically thereon since technical interpretations are only provided with regard to hypothetical situations. We will, however, attempt to provide some general comments concerning the above-noted provision of the Act in a hypothetical situation where a corporation ("Parent") has made an interest-free loan of funds to a corporation controlled by it ("Subco") which carries on an active business; the debt so owing to the Parent is settled by Subco through the issuance of additional shares in its capital stock to Parent at a time when the fair market value of Subco is less than the principal amount outstanding with respect to this debt due to business losses sustained by Subco; and the terms of the debt were not such that the provisions of subsection 51(1) of the Act are applicable to the Parent's acquisition of such additional shares in the capital stock of Subco.
Generally the Department does not consider that an interest-free loan of funds would constitute a debt acquired by the lender for the purpose of gaining or producing income from a business or property unless the conditions outlined in paragraph 6 of Interpretation Bulletin IT-239R2 are met. Therefore in our opinion any capital loss realized by Parent on the settlement of the debt as detailed above will be deemed to be nil pursuant to subparagraph 40(2)(g)(ii) of the Act.
In our opinion, where the Parent held the debt as capital property for the purposes of the Act, the provisions of subsection 85(4) of the Act will apply to add proportionately the amount of Parent's capital loss on the disposition of this debt to the adjusted cost base of all the shares in the capital stock of Subco held by Parent. The provisions of paragraph 69(1)(a) of the Act will not be applicable to deny the addition provided for in subsection 85(4) of the Act.
It should be noted that these comments are an expression of our opinion based on the above hypothetical situation and that the application of the provisions of the Act to an actual situation can only be determined after all of the relevant facts of the particular situation have been considered.
We hope our comments will be of assistance to you.
Yours truly,
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch