When a commercial obligation is settled or extinguished for an amount less than the principal amount of the debt, Section 80 applies the debt forgiveness rules. CRA notes that the forgiven amount is applied to reduce “tax balances” or is included in the debtor’s income under Subsection 80(2) or (13).
In a June 21, 2017 French Technical Interpretation (2016-0678361E5, Seguin, Marc), CRA opined that a deemed gain due to a limited partner’s negative adjusted cost base (under Subsection 40(3.1)) could not be added to that limited partner’s capital dividend account. CRA opined that partnership income generally retains its nature and character when allocated out to partners.
DEBT FORGIVENESS – TIERED PARTNERSHIPS
When a commercial obligation is settled or extinguished for an amount less than the principal amount of the debt, Section 80 applies the debt forgiveness rules. CRA notes that the forgiven amount is applied to reduce “tax balances” or is included in the debtor’s income under Subsection 80(2) or (13).
Section 80 requires that the forgiven amount be applied in the following order:
- non-capital losses (Paragraph 80(3)(a));
- farm losses (Paragraph 80(3)(b));
- restricted farm losses (Paragraph 80(3)(c));
- allowable business investment losses (Paragraph 80(4)(a)); and
- net capital losses (Paragraph 80(4)(b)).
After the mandatory application of the forgiven amount, the debtor may elect to apply the remaining forgiven amount to reduce the capital cost of depreciable property (Subsection 80(5)); cumulative eligible capital (Subsection 80(7)); resource expenditures (Subsection 80(8)); capital properties (Subsection 80(9)); certain shares and debts(Subsection 80(10)); certain shares, debts and partnership interests (Subsection 80(11)); and current year net capital losses (Subsection 80(12)). If there is still a residual balance, half of the amount will be added to the taxpayer’s income (Subsection 80(13)). The rules are modified slightly for partnerships.
In a March 22, 2017 Technical Interpretation (2016-0666481E5, Gibbons, Jim), CRA considered the impact of the debt forgiveness rules on a forgiven amount in a tiered partnership. While general comments were provided, CRA specifically opined on the implications where a bottom partnership (BP) is wound up into the top partnership (TP) in the same year a forgiven amount is included in the BP’s income(Subsection 8(13)).
CRA noted that the BP would have a deemed year-end immediately before the time it ceased to exist. Therefore, the BP’s income inclusion would occur in the deemed fiscal period, and, as a partner of the BP, the TP could deduct an amount in respect of the relevant limit which would then be deemed to be a commercial debt obligation that the TP issued and was settled at the end of the BP’s deemed fiscal period (Subsection 80(15)). The TP could then apply the forgiven amount to their own tax attributes (under Subsections 80(5) to (10)).
CRA also noted that the forgiven amount could only be applied against the adjusted cost base of the TP’s interest in the BP if the BP and theTP were not related (e.g. the TP only had a minority interest in the BP) under Subsection 80(9).
The balance of any forgiven amount, after applying Subsections 80(5) to (10), would be included in the TP’s income (Subsection 80(13)) and allocated to its members.
As the TP would be deemed (Subparagraph 80(c)(i)) to have issued a commercial debt obligation that was settled at the end of the BP’s deemed fiscal period, Subsection 8(15) would also apply to the partners. Thus, the partners would be able to claim a deduction (Subparagraph 80(15)(a)) up to the relevant limit which could then be treated as a forgiven amount and applied against the taxpayer’s own tax attributes
