Release from Debt Obligation – Proposal in Bankruptcy
St-Hillaire v The Queen, 2014 TCC 336
[See also the decision in Gaumond v The Queen, 2014 TCC 339]
At issue was when a debt ceases to exist for purposes of the Allowable Business Investment Loss provisions of the Income Tax Act.
The court determined that for tax purposes, where a shareholder waives the right to liquidation dividends and this results in a termination of the debt under the terms of a proposal in bankruptcy, the debt ceases to exist at the time the proposal is accepted by the creditors.
The taxpayer claimed an Allowable Business Investment Loss (ABIL) on the basis of loans made to his wholly owned company that after a proposal in bankruptcy was accepted by the unsecured creditors of the company. The CRA denied the loss, and subsequent carrying charges, because the taxpayer had waived his right to terminal dividends on the proposal being accepted, in their opinion cancelling the debt.
The corporation’s year end was October 31 of the year, and the corporation reported and paid tax on the gain on the disposition of the debt on its year-end return.
Paragraph 38(c) defines the taxpayer’s ABIL to be 1/2 of the taxpayers business investment loss for the year from the disposition of property, and paragraph 39(1)(c) defines what a taxpayers business investment loss for a year is. In order for a debt to qualify for the ABIL provisions, the debt must be a bad debt as defined in subsection 50(1), which requires that the debt be “owing to the taxpayer at the end of a taxation year” (paragraph 50(1)(a)).
Where the taxpayer, whose taxation year ends on December 31 (ITA 249(1)), is not owed a debt at the end of the taxation year, there is no property the disposition of which could result in a loss as required by sections 38 and 39, as there is no debt that could become a bad debt pursuant to subsection 50(1).
The Bankruptcy and Insolvency Act does not expressly state when a debtor is released from the debt obligation where a proposal in bankruptcy is accepted by the creditors. There are two theories as to the timing of the release:
- The time for the partial discharge of a debt, and partial release of a debtor, is when the trustee’s discharge order is issued or when the trustee issues a certificate that the proposal has been fully performed: Rita Congiu and 9100-7146 Québec Inc. v. The Queen, 2014 FCA 73, citing Rita Congiu c. L’Agence du Revenu du Québec, 2014 QCCA 242.
- The time for the partial discharge of a debt, and partial release of a debtor, is the date the court ratifies the proposal after it has been accepted by the creditors: Réal Martel v. Her Majesty the Queen, 2010 TCC 634; Anderson v. Canadian Imperial Bank of Commerce (1999), 11 C.B.R. (4th) 157 (Ont SCJ).
The court noted that in addition to the results of the two approaches, the court must also consider the effect of the waiver of all liquidation dividends and the recognition of a gain by the corporation on the settler to the debt in its financial statements (para 38). In this case, the waiver of the liquidation dividends resulted in the debt being written off under the terms of the proposal in bankruptcy and ceasing to exist. This was in line with the corporation recognizing a gain in its year-end financial statements on the disposition of the debt on October 31, before the end of the year.
– Sas Ansari, JD LLM PhD (exp)
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