IT142R3- Settlement of debts on the winding-up of a corporation

NO: IT-142R3

DATE: January 11, 1988

SUBJECT: INCOME TAX ACT
Settlement of debts on the winding-up of a corporation

REFERENCE: Subsection 80(3) (also section 21 , subsections 10(1), 12(3), 12(6), 18(2), 18(3.1), 80(1), 80(4), 88(1) and 248(1)).

Application

This bulletin replaces and cancels Interpretation Bulletin IT-142R2 dated May 22, 1984. Current revisions are designated by vertical lines.

Summary

This bulletin deals with an election that may be filed by a parent corporation where inter-company debt is settled or extinguished on the winding-up of its subsidiary under subsection 88(1). The election generally operates to ensure that subsection 80(1) will not apply unless the cost amount of the debt is less than both the principal amount of the debt and the amount for which it was issued.

Discussion and Interpretation

1. On the winding-up of a subsidiary corporation into its parent, a debt or obligation owing by the subsidiary to its parent or by the parent to its subsidiary may be settled or extinguished

(a) without any payment, or

(b) by payment of an amount that is less than both the principal amount (see 4(a) and (b) below) of the debt or obligation and the amount that would have been the cost amount (see 4(c) and (d) below) to the parent or subsidiary, as the case may be, of the debt or obligation at the time that is immediately before the winding-up.

2. Where an intercorporate debt as envisaged in 1 above is settled or extinguished after 1983 in the circumstances described in 1(a) or (b) above and the winding-up has been effected in accordance with the rules in subsection 88(1), the parent can elect under subsection 80(3) to have the debt or obligation deemed to have been settled or extinguished by payment of an amount that would have been its cost amount (see 4(c) and (d) below) to the parent or the subsidiary, as the case may be.

3. Regardless of which corporation is the debtor or creditor, only the parent corporation can elect to invoke the deeming provision of subsection 80(3). The election must be made in prescribed form (T2027) on or before the day on or before which the parent is required to file a return of income for the taxation year during which the debt or obligation was settled or extinguished.

4. For the purpose of subsection 80(3),

(a) the “principal amount” of a debt or obligation is defined in subsection 248(1). Briefly, it is the maximum amount that is payable by the issuer of a debt or obligation under its terms or the terms of any related agreement, exclusive of all interest and advance redemption premium. See (c) below for the definition of “cost amount” of a debt or obligation.

(b) “deemed principal amount”. Subsection 80(4) was enacted by S.C. 1985, c.45 to deem a principal amount for certain interest payable (referred to in this bulletin as a “deemed principal amount”) in respect of a debt or obligation that is settled or extinguished after May 9, 1985. Such deemed principal amount is separate and distinct from the principal amount described in (a) above and consists of the portion of unpaid interest that the issuer (i.e., the debtor) of a debt or obligation has, in any taxation year, deducted in computing income or that would have been so deductible except for any of subsections 18(2) or (3.1) or section 21. See (d) below for the definition of “cost amount” of such unpaid interest.

(c) the “cost amount” of a debt or obligation, referred to in (a) above, immediately before the winding-up is the amount determined when the definition of “cost amount” in subsection 248(1) is read without reference to paragraph (e) thereof. Therefore if a debt or obligation is a capital property to the creditor its cost amount will be its adjusted cost base and if the debt or obligation is inventory to the creditor its cost amount will be its inventory value, pursuant to subsection 10(1), for the purpose of computing the creditor’s income.

(d) the “cost amount” of the deemed principal amount in respect of unpaid interest, referred to in (b) above, will be determined under the definition of “cost amount” in subsection 248(1) which, by virtue of subsection 80(3), is to be read without reference to paragraph (e) thereof. Accordingly, such cost amount will be the amount of unpaid interest that, at the time that is immediately before the time at which the debt or obligation in respect of unpaid interest is settled or extinguished, the creditor has included in income.

It should be noted that prior to the amendment referred to in (b) above, subsection 80(3) did not apply with respect to interest on a debt or obligation.

5. Where the parent corporation has elected under subsection 80(3), the deemed principal amount in respect of unpaid interest on an intercorporate debt or obligation will be deemed to have been settled for an amount equal to the amount thereof that the creditor has included in income (i.e., its cost amount). Since there is a deemed settlement , the creditor will not be entitled to any deduction, under paragraph 20(1)(l) or (p), in computing income with respect to accrued interest receivable. Until the debt or obligation has been settled or extinguished the debtor is unaffected with respect to the deductibility of accrued interest payable as provided by the Act.

6. A valid election under subsection 80(3) may prevent the application of the rules in subsection 80(1). However, in spite of such a valid election having been made, subsection 80(1) will still apply to a debtor with respect to the amount, if any, by which the principal amount of the debt or obligation exceeds its cost amount to the creditor. This situation can occur because the “principal amount” is an amount determined from the debtor’s viewpoint while the “cost amount” is determined from the creditor’s viewpoint and is subject to such influences as inventory valuation and the non-application of subsection 12(3) in circumstances described in subsection 12(6).

7. An election under subsection 80(3) by a parent corporation affects only the settling or extinguishing of debts or obligations existing between a parent corporation and its subsidiary corporation and only when the subsidiary has been wound-up in accordance with the rules in subsection 88(1).

8. On the winding-up of a corporation,

(a) where the rules in subsection 88(1) do not apply, or

(b) with respect to debts or obligations between the corporation being wound-up and persons, including shareholders other than the parent, where subsection 88(1) does apply, debts or obligations are sometimes settled or extinguished without a formal payment in cash. Nonetheless, where, as a result of a particular arrangement made on the winding-up, a debt can reasonably be considered to have been settled for an amount that is not less than the principal amount thereof outstanding and, with respect to debts or obligations settled or extinguished after May 9, 1985, for an amount that is not less than the deemed principal amount thereof outstanding, payment in full is considered to have been made and the provisions of subsection 80(1) of the Act do not apply. Generally, in the case of a shareholder, settlement of the debt is achieved by adjusting the amount received by the shareholder as part of the winding-up distribution to reflect the debt settled or extinguished.

9. Examples of such arrangements made on the winding-up of a corporation are:

(a) A debt or other obligation owed by a shareholder to the corporation is offset against an amount owing to that shareholder by the corporation.

(b) A debt or other obligation owed by the corporation to a person other than a shareholder is assumed by a shareholder.

(c) A debt or other obligation of the corporation is assigned to a shareholder together with property distributed to that shareholder, for example, a mortgage on a building.

10. Where a non-cash settlement of a debt on a winding-up, such as those mentioned above, cannot be considered to constitute full payment of the principal amount of the debt, the provisions of subsection 80(1) apply. See also Interpretation Bulletin IT-293R.

Link to Source: https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/it142r3/archived-settlement-debts-on-winding-a-corporation.html

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