Relief from Debt-Forgiveness Inclusions: The Basics
When a taxpayer cannot service debt because of financial distress, a
creditor may forgive all or a portion of the debt. The debt forgiveness
may trigger an income inclusion under subsection 80(13), but a taxpayer
in financial distress may not be able to pay the tax on the inclusion.
The purpose of sections 61.2, 61.3, and 61.4 is to provide relief to
certain taxpayers facing subsection 80(13) income inclusions.
Section 61.2 provides a reserve on a subsection 80(13) income
inclusion if the debtor is an individual (other than a trust) resident
in Canada. The reserve, which is claimed net of paragraph 80(15)(a)
deductions, allows the subsection 80(13) income inclusion to be deferred
to future years when the taxpayer earns more income. The reserve begins
to decrease at a rate of 20 cents per $1 of income earned in excess of
$40,000. Therefore, the income inclusion will never be taxed if the
individual never earns income in excess of $40,000, or if he or she dies
in a taxation year in which the reserve is still eligible to be
Section 61.3 provides an offsetting deduction to corporations
resident in Canada (unless they are exempt from part I tax) that limits
the income inclusion to twice the FMV of the corporation's net assets.
This offsetting deduction is aimed at ensuring that the corporation's
tax liability from the income inclusion will not exceed the FMV of its
net assets. As is the case for many insolvent corporations, a net asset
value of zero will result in a deduction equal to the full amount of the
subsection 80(13) income inclusion. Subsection 61.3(1) (for resident
corporations) and subsection 61.3(2) (for non-resident corporations)
function in the same manner.
The rules in section 61.3 are subject to an anti-avoidance provision.
Subsection 61.3(3) restricts the deduction when property transfers are
made within the 12-month period before the end of the year if it is
reasonable to conclude that the reason for the property transfer was to
increase the available deduction for the year under subsection 61.3(1)
or subsection 61.3(2). If subsection 61.3(3) applies, the lender and the
borrower referred to in the subsection are jointly and severally liable
for any tax liabilities arising from a subsection 80(13) income
inclusion (subsection 160.4(1)).
While sections 61.2 and 61.3 provide relief for financially
distressed Canadian-resident individuals or corporations, section 61.4
allows a reserve to be claimed on a subsection 80(13) income inclusion
if the debtor is any of the following (with some exceptions): (1) a
non-resident person that carried on business through a fixed place of
business in Canada, (2) a corporation resident in Canada, or (3) a trust
resident in Canada. The section 61.4 reserve also differs in that the
subsection 80(13) income is required to be included in the corporation's
income at a minimum rate of 20 percent per year. Therefore, the income
inclusion will be brought into income over a maximum five-year period.
MNP LLP, Winnipeg