August 2020 Newsletter

If you have a loan or debt that is forgiven or cancelled, you may be subject to adverse income tax consequences. The “debt forgiveness” rules under the Income Tax Act may apply to reduce some of your tax attributes or tax costs in a detrimental way, and in some cases, they may result in an income inclusion.

The debt forgiveness rules apply only if interest on the debt was or would have been deductible for you for income tax purposes. Basically, this means that the rules can apply to forgiven debt that was used for income‑earning purposes, such as to earn investment income like interest, dividends or rent, or if the debt is used in a business. Personal debt such as student loans, or loans to purchase a personal-use car or property or to finance a vacation, are not caught by the rules.

General rules

Trusts and estates are treated as individuals and taxpayers under the Income Tax Act. As such, they must report any income and pay tax on their taxable income, if any.

Although they are considered individuals, most trusts do not qualify for the graduated tax rates that apply to other individuals. Most trusts are subject to a flat tax equal to the highest marginal rate that applies to other individuals. The federal rate is 33% and the provincial rate depends on the province. The combined federal and provincial rate is typically around 50% or more.

If you own a building and the surrounding land that is used in your business, or as a rental property, you can depreciate the cost of the building for income tax purposes. The tax depreciation is called “capital cost allowance”, and the depreciation pool at the end of every year is called the undepreciated capital cost (UCC).

If you sell the building for an amount that is less than the remaining UCC pool, you will have a terminal loss, which is normally fully deductible in computing your income. 

Supreme Court Confirms Linkage Principle for Hedging Transactions

In the MacDonald case, the Supreme Court of Canada upheld what has been known as the “linkage principle” applicable to certain derivative contracts. Basically, the principle holds that if there is sufficient linkage between a derivative contract and the value or amount of a property, liability, or transaction, so that the derivative is effectively a “hedge”, then the gains or losses on the derivative for income tax purposes take on the character of the property, liability or transaction being hedged.