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Debt forgiveness rules: can we really talk about forgiveness? (Part 2)

Article written by STEVE YOUN, CPA, CA DE DMCL in the quarterly overview of Canadian news, a newsletter published by the Canadian member firms of Moore North America. This article on debt forgiveness is part of our mission to become your partner in success by keeping you informed. Didn’t you read the first part on the subject? Start reading here.

Debt forgiveness rules: can we really talk about forgiveness? (Part 2)

Minimize the impact of the amount remitted

The following practical strategies can minimize the amount forgiven under the debt forgiveness rules:

Transfer of remitted amount

If there is a residual balance of the forgiven amount after the application of subsections 80(3) to (10), section 80.04 authorizes the debtor corporation to transfer the balance of the forgiven amount to reduce the tax attributes of any corporation or partnership related to the debtor and referred to as an “eligible transferee”.

Transfer of depreciable property to a subsidiary

To illustrate the designation of section 80.04, imagine a scenario in which a debtor corporation has a forgiven amount of $100 and does not want the application of subsection 80(5) to reduce its undepreciated capital cost (UCC). Fortunately, the debtor company has a sister company (“LossCo”) with no losses other than capital losses of $100 to draw on, and a merger is not an option for business reasons. The debtor company can incorporate a subsidiary (“SubCo”) and transfer the depreciable asset to it before applying the debt forgiveness rules. Thus, the debtor company may choose to apply article 80.04 and assign the amount remitted to LossCo without triggering a reduction in SubCo’s UCC.

This is because, as mentioned in the summary of rules, the debtor corporation must apply the amount remitted to tax attributes under subsections 80(3) to 80(10) before it can elect the section 80.04 option. If the debtor company decides to keep the depreciable asset, the option of article 80.04 will not be available.

Retention of discretionary deductions

The debt forgiveness rules stipulate that the amount forgiven must apply first to non-capital losses and to the balance of capital losses, respectively. The debtor company can then designate an amount to reduce the UCC or the balance of the cost of capital. As this is a designation, this reduction is not mandatory. Alternatively, the debtor corporation can simply elect to have subsection 80(13) apply, i.e., to include 50% of the unapplied forgiven amount in income. This latter choice can be advantageous when, rather than reducing the tax attributes of the total rebate amount, the debtor corporation can use a discretionary deduction, such as capital cost allowance, to reduce the 50% income inclusion under subsection 80(13), thereby preserving the tax attributes for future years.

It should be noted that if the creditor attempts to transfer the trade debt to a person related to the debtor company for less than 80% of its principal amount, the debt may be considered a “remitted debt”, as defined in subsection 80.01(7) of the Act. Income Tax Act (ITA) to which the debt forgiveness rules would apply.

Deduction of provisions under the income inclusion rule

If none of the above planning options apply, the debtor corporation may consider deducting reserves under sections 61.3 and 61.4 of the ITA to help meet the income inclusion rule of subsection 80(13).

For certain insolvent corporations, section 61.3 provides a deduction that effectively limits the income inclusion rule in subsection 80(13) to twice the fair market value of the corporation’s net assets at year-end. In its technical notes on the provision, the Department of Finance explains that – based on a tax rate of 50% or less – this rule ensures that the company’s liabilities will not exceed the fair market value of its assets at year-end. Under the income inclusion rule referred to in subsection 80(13), an insolvent corporation should have zero net asset value after a full deduction.

Note that the deduction under section 61.3 can apply to both resident and non-resident corporations, provided they are not exempt from Part I tax. In addition, when claiming the deduction under section 61.3, debtor corporations should consider the anti-avoidance provision in subsection 61.3(3), as it limits the deduction in the following cases: a) the assets are transferred within a 12-month period (of a given year); b) it is reasonable to assume that one of the reasons for the transfer was to increase the deduction under section 61.3.

For solvent corporations, section 61.4 allows a reserve to defer income inclusion under subsection 80(13) for up to five years (with a minimum balance of 20% per year). This option is available to a corporation or trust resident in Canada, or to a non-resident person who carries on business through a fixed place of business in Canada during the year.

Key points to remember

Debt forgiveness rules are varied and quite complex, and we’d like to see them applied more regularly as British Columbians continue to suffer the economic impact of the COVID-19 pandemic. Fortunately, many planning strategies and opportunities are available to corporate debtors who wish to minimize income inclusion.

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