Forgiveness of Debt Rules

There are extremely complex rules dealing with situations where taxpayers who have commercial obligations (debt) and that debt is settled for less than the principal amount. If the debt is personal or non-commercial in nature, nothing happens. In these cases, the debt is defined to include debt where the interest is not deductible for income tax purposes. Commercial debt is debt where interest is deductible for income tax. To be deductible, it must have been incurred to earn income from a business or property. However, even in cases where the debt was non-interest bearing, the debt forgiveness rules apply where interest, if paid or payable, would have been tax deductible. Where commercial debt is forgiven, the forgiven amount is subject to certain special tax treatment.

The forgiven amount (the amount not repaid) must be accounted for under the forgiveness of debt rules in Section 80 of the Income Tax Act. CAUTION, these rules are extremely complex and professional advice needs to be obtained. Careful tax planning with a Chartered Accountant is necessary in all circumstances. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

The forgiven amount must be applied to the following accounts in the specific order presented. This is a mandatory requirement:

1. Section 80(3)(a), unused non-capital (business) losses of prior taxation years starting with the oldest first. This does not include losses in the current taxation year.

2. Section 80(3)(b), unused farm losses of prior taxation years starting with the oldest first. This does not include losses in the current taxation year.

3. Section 80(3)(c), unused restricted farm losses of prior taxation years starting with the oldest first. This does not include losses in the current taxation year.

4. Section 80(4)(a), unused allowable business investment losses of prior taxation years starting with the oldest first. This does not include losses in the current taxation year.

5. Section 80(4)(b), unused net-capital (investment) losses of  prior taxation years starting with the oldest first. This does not include losses in the current taxation year.

If there is a balance of unapplied forgiven amounts then, at the option of the debtor, the following amounts are reduced again in order of presentation. Form T2154 must be filed to claim this election:

1. Section 80(5), the undepreciated capital cost of depreciable property.

2. Section 80(7), the balance in the cumulative eligible capital property pool.

3. Section 80(8), any resource account balances like CDE or COGPE.

4. Section 80(9), as long as the maximum was claimed under Sections 80(5) to 80(8), the adjusted cost base (ACB) of non-depreciable capital property except for shares or debt where the debtor is a specified shareholder and some other exceptions.

5. Section 80(10), as long as the maximum was claimed under Sections 80(5) to 80(9), the ACB of shares or debt of unrelated companies in which the taxpayer is a specified shareholder.

6. Section 80(11), as long as the maximum was claimed under Sections 80(5) to 80(10), the ACB of shares or debt of related companies.

7. Section 80(12), as long as the maximum was claimed under Sections 80(5) to 80(9), current year capital losses.

If after the debtor has applied the optional reductions above a balance remains, then 50% of the balance is income to the taxpayer. The taxpayer may then be eligible for a reserve to spread the recognition of income over time. The reserve calculation is complex and may be reversed by the tax department unless all of the optional reductions have been used.

If the taxpayer has allocated the maximum amounts up to and including Section 80(10), then a special election under Section 80.04 may be made. Form T2156 must be filed. The election allows the remaining amounts to be transferred to an eligible transferee. An eligible transferee is a Taxable Canadian Corporation which is related to the debtor. The transferee then applies the amounts under Sections 80(3) to 80(10) and then to Section 80(12). Section 80(11) reductions are not allowed. If any amounts remain unapplied in the transferee, then the transferee has an income inclusion of 50% with no ability for a reserve.

CAUTION, these rules are extremely complex and professional advice needs to be obtained. Careful tax planning with a Chartered Accountant is necessary in all circumstances. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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