Principal Issues: Whether the position in the last sentence of paragraph 25 of IT-293R (Archived) is still valid and remains unchanged.
Position: No (for debts settled or extinguished on or after November 2, 2023).
Reasons: (1) The nature of a debtor's trade debt or gain from the forgiveness of a trade debt does not change automatically solely because of the passage of time of a taxation year or several taxation years. Also, the time at which a trade debt is settled or extinguished, does not (in and by itself) convert the nature of a transaction of forgiveness of trade debt from current account to capital account; (2) the legislator's intent is that gains on the settlement or extinguishment of trade debts that are on account of income must be included in the computation of the taxpayers' profit or loss of a business or property pursuant to section 9 ITA; (3) more accurate picture of the taxpayer's profit (as required by the analytical framework set out in the SCC decision Canderel Limited); (4) there is no rule of law in the Canadian case law that would provide that the nature of a debtor's trade debt or gain from the forgiveness of a trade debt changes automatically solely because of the passage of time of a taxation year or several taxation years; (5) the decision of the House of Lords in the case British Mexican has been distinguished in certain subsequent Canadian cases, including Alco Dispensing Canada Ltd., Enjay Chemical Co. Limited and Oxford Motors Limited.
1. FEDERAL TAX ROUNDTABLE, OCTOBER 2, 2023
APFF CONFERENCE 2023
Interpretation Bulletin IT-293R “Debtor's gain on settlement of debt”
Interpretation Bulletin IT-293R, (footnote 1) states at paragraph 25:
“Trade Debts Forgiven
25. As mentioned in 19(e) above, forgiveness of a trade debt in the same taxation year in which it was incurred is required to be included in computing the debtor's income for that year under the general rules for computing profit from a business or property. Where the debt forgiven is in respect of merchandise or other property in which the debtor deals, the cost of the property acquired is reduced by the amount of forgiveness whether or not it was sold in the year in which the debt was forgiven. Where the forgiveness occurs in a taxation year subsequent to that in which the debt was incurred, the same general rules of profit computation require that an amount be included in the profit computation for the year of forgiveness equal to that portion of the forgiven debt that relates to the inventory of merchandise on hand at the beginning of that year. In other circumstances under which a trade debt is forgiven, the rules described in 1 above apply (subject to any applicable exclusions described in 15 above).”
[Emphasis added.]
It is our understanding that the reference to "In other circumstances under which a trade debt is forgiven, the rules described in 1 above apply” in paragraph 25 above provides that a gain arising on the forgiveness of debt in such circumstances (i.e., where the forgiveness occurs in a taxation year subsequent to the year in which the debt was incurred and the debt does not relate to inventory at the beginning of the taxation year in which the forgiveness occurs) is not required to be included in computing the taxpayer's income pursuant to section 9 of the Income Tax Act, (footnote 2) and I.T.A. section 80 is applicable (the "Position").
This Position has existed for a long time and was already provided for in paragraph 15 of the former Interpretation Bulletin IT-293 (footnote 3). The CRA's Position was based (footnote 4) on the reasons expressed by the House of Lords in The British Mexican Petroleum Co. Ltd. v. Jackson (H.M. Inspector of Taxes) (footnote 5).
In 2000-0051797, (footnote 6) the CRA stated in 2002 that Interpretation Bulletin IT-293R would likely have to be revised to take into account new legislation and relevant case law. However, Interpretation Bulletin IT-293R was not subsequently amended or replaced by an income tax folio.
Question to the CRA
Is this Position still valid and unchanged?
CRA Response
That position is no longer valid.
The CRA is now of the view that the nature of a trade debt (a "trade debt" as defined in Interpretation Bulletin IT-293R, i.e., a debt incurred in respect of an expense that is deductible in computing income) of a debtor or a gain of a debtor from the settlement or extinguishment of a trade debt does not automatically change by reason only of the passage of time in a taxation year or taxation years. Furthermore, the time (in and of itself) at which a trade debt is settled or extinguished does not convert the nature of a debt forgiveness transaction from income to capital.
In our view, Parliament's intention is that debtors' gains on income account from the settlement or extinguishment of trade debts should be included in computing the debtors' profit or loss from a business or property pursuant to section 9 (for the purpose of determining taxpayers' income from a business or property).
Where a taxpayer realizes a gain on income account on the settlement or extinguishment of a trade debt, the gain must be included in computing the taxpayer's profit from a business or property pursuant to section 9, because this provides a truer picture of the taxpayer's profit or loss (as required by the Supreme Court of Canada's analytical framework in Canderel Limited v. Canada (footnote 7).
There is no established principle (or rule of law) in Canadian jurisprudence that provides that the nature of a debtor's trade debt or of a debtor's gain from the forgiveness of a trade debt changes automatically merely because of the passage of time in a taxation year or a number of taxation years.
The decision of the House of Lords in British Mexican has been distinguished in a number of subsequent Canadian decisions, including Alco Dispensing Canada Ltd. v. The Queen (footnote 8), M.N.R. v. Enjay Chemical Co. Limited (footnote 9) and Oxford Motors Limited v. M.N.R. (footnote 10).
For example, in Alco Dispensing, the issue was whether former paragraphs 80(1)(a) and 80(1)(b) or section 9 and former paragraph 80(1)(f) were applicable by virtue of the taxpayer's cancellation in its 1987 taxation year of its obligation to pay bonuses that had been incurred and deducted in computing its income for its 1986 taxation year. Justice Bonner of the Tax Court of Canada concluded that the bonus release transaction had to be reflected in the taxpayer's income in the taxation year of the release. Justice Bonner distinguished the Alco Dispensing case from the British Mexican case on the basis that the purpose of the debt forgiveness was not to shore up the shaky financial structure of the taxpayer. The Justice stated in particular that the release of the liability to pay the bonuses could not be treated as having changed the character of the liability, that the assertion that the forgiveness of the bonus was a capital transaction was clearly illogical, and it was contrary to common sense (a common sense commercial view of the matter should be taken) to assert that the passage of a year end effects some sort of a magical conversion of executive compensation operations from current account transactions to capital account transactions.
The change in position is applicable to debts settled or extinguished on or after November 2, 2023.
Robert Gagnon
November 2, 2023
2023-097542
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 CANADA REVENUE AGENCY, Interpretation Bulletin IT-293R (archived) “Debtor's gain on settlement of debt”, July 16, 1979.
2 R.S.C., 1985, c. 1 (5th Supp.)(I.T.A.)
3 CANADA REVENUE AGENCY, Interpretation Bulletin IT-293 (cancelled), “Debtor's gain on settlement of debt”, February 23, 1976.
4 CANADA REVENUE AGENCY, memorandum 2000-0051797, July 7, 2002.
5 (1932) 16 T.C. 570 (House of Lords) (« British Mexican »).
6 CANADA REVENUE AGENCY, supra, footnote 4.
7 [1998] 1 R.C.S. 147, para. 53, 98 DTC 6100 (S.C.C.).
8 96 DTC 1586 (T.C.C..), affirmed by the Federal Court of Appeal in 97 DTC 5463 (F.C.A.), substantially for the reasons offered in the T.C.C. judgment ("Alco Dispensing").
9 71 DTC 5293 (F.C.T.D.).
10 [1959] S.C.C. 548, 59 DTC 1119 (S.C.C.).