Principal Issues: Whether the reduction of amounts pursuant to subsection 80(4) should be taken into consideration in computing the capital dividend account ("CDA") of a private corporation.
Position: No.
Reasons: Wording of the Act. Paragraph 80(4)(b) reduces the net capital losses of a corporation where a commercial obligation issued by a debtor is settled and a forgiven amount results from such settlement of debt. Technically, paragraph 80(4)(b) has no effect on the amount of capital losses and allowable capital losses sustained by a taxpayer. In comparison, subparagraph (a)(ii) of the definition of CDA in subsection 89(1) deals with the capital losses and allowable capital losses sustained by the taxpayer in the relevant period. Technically, this provision does not refer to the net capital losses of a taxpayer.
September 28, 2006
Laval Tax Services Office Income Tax Rulings Directorate Revenue Collection and Customer Services S. Prud'Homme 3400 Jean-Béraud Avenue (613) 957-8975 Laval QC H7T 2Z2
Attention: Ms. Sylvie Bordeleau 2006-020290
Impact of subsection 80(4) of the Income Tax Act on the calculation of the capital dividend account
This is in response to your fax of August 25, 2006, in which you requested our opinion on the impact of subsection 80(4) of the Income Tax Act (the "Act") on the calculation of a corporation's capital dividend account ("CDA") in a particular situation (the "Particular Situation").
Unless otherwise stated, any statutory reference herein is to a provision of the Act.
(1) Particular Situation
A private corporation (the "Corporation") incurred net capital losses in certain taxation years.
Subsequently, a commercial debt issued by the Corporation was settled. A "forgiven amount" within the meaning of subsection 80(1) resulted from this forgiveness of debt. Under subsection 80(4), a portion of that forgiven amount was applied against the Corporation's net capital losses.
Finally, in a subsequent taxation year, the Corporation made an election to pay a capital dividend to its shareholders of a certain amount pursuant to subsection 83(2).
In a schedule filed by the Corporation showing the calculation of its CDA for the relevant period, the amount referred to in subparagraph (a)(ii) of the definition of CDA in subsection 89(1) was reduced to take account of the reduction in the Corporation's net capital losses resulting from the application of subsection 80(4). The effect of that transaction was to increase the amount of CDA available to the Corporation.
(2) Your Question about the Particular Situation
You wish to know whether the reduction in net capital losses resulting from the application of subsection 80(4) should be taken into account in calculating the Corporation's CDA.
(3) Our Comments on the Particular Situation
In very general terms, paragraph 39(1)(b) provides that a taxpayer's capital loss for a taxation year from the disposition of any property is the taxpayer's loss for the year, determined under subdivision c of Division B of Part I of the Act, from the disposition of any property of the taxpayer (other than property described in subparagraphs 39(1)(b)(i) and (ii)).
Paragraph 38(b) provides that a taxpayer's allowable capital loss for a taxation year from the disposition of any property is one-half of the taxpayer's capital loss for the year from the disposition of that property. In that regard, the reference in paragraph 38(b) to "one-half" should be replaced by "3/4" or "2/3", depending on the previous taxation year in question.
Furthermore, under the definition of "net capital loss" in subsection 111(8), a taxpayer's net capital loss for a taxation year is the result of the computation of A - B + C - D. The A, B and D components of this computation are relevant to this case. In very general terms, A refers to the taxpayer's allowable capital losses for the year. Element B generally refers to the taxable capital gains realized by the taxpayer for the year. Finally, D is the total of the amounts to be applied against the taxpayer's net capital loss for the year because of section 80.
Paragraph 80(4)(b) provides that on the settlement of a commercial obligation issued by a debtor, the applicable fraction (as defined in paragraph 80(2)(d)) of the remaining unapplied portion of a forgiven amount of the obligation at the time of settlement in respect of the obligation shall be applied to reduce the debtor's net capital loss for each taxation year that ended before that time.
Furthermore, paragraph (a) of the definition of CDA in subsection 89(1) is the amount by which the total in subparagraph (a)(i) exceeds the total in subparagraph (a)(ii). In very general terms, subparagraph (a)(i) refers to the amount, if any, by which the corporation's capital gains realized in the relevant period exceed the corporation's corresponding taxable capital gains. In summary, subparagraph (a)(ii) refers to the amount, if any, by which the corporation's capital losses incurred in the relevant period exceed the corporation's allowable capital losses.
It follows from the above that in a debt forgiveness situation, paragraph 80(4)(b) results in a reduction of a taxpayer's net capital losses. Technically, this statutory provision has no effect on the capital losses or allowable capital losses of a particular corporation. By comparison, subparagraph (a)(ii) of the definition of CDA in subsection 89(1) refers to the capital losses and allowable capital losses incurred by a particular corporation during the relevant period. Technically, this statutory provision does not refer to the net capital losses of a particular corporation.
Based on the foregoing, we are of the view that the reduction in net capital losses resulting from the application of subsection 80(4) in the Particular Situation has no impact on the calculation of the Corporation's CDA. Thus, the amount referred to in subparagraph (a)(ii) of the definition of CDA in subsection 89(1) should not be reduced as a result of the reduction in the Corporation's net capital losses due to subsection 80(4). The calculation of the CDA available to the corporation for the relevant period should therefore continue to take into account the non-deductible portion of the corporation's capital losses incurred in the relevant period, notwithstanding the application of subsection 80(4).
One reason for the above result may be that, in the Particular Situation, the Corporation will not only have actually incurred capital losses during the relevant period, but those capital losses will actually have been used under subsection 80(4) to offset a portion of the forgiven amount on the debt that would otherwise, to the extent not reduced under subsections 80(3) to (12), have been required to be included in the Corporation's income under subsection 80(13). In other words, the Corporation may be considered to have effectively used up its capital losses in order to avoid the inclusion of an amount in its income resulting from the debt forgiveness. Given that the Corporation will have incurred and utilized its capital losses, it could be argued that it makes sense for the non-deductible portion of those capital losses to continue to be taken into account in calculating the Corporation's CDA.
Should you require further information on this subject, please do not hesitate to contact us.
Stéphane Prud'Homme, Notary, M. Fisc.
For the Director
Corporate Reorganizations and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch