Due to the economic climate, there is currently an increase in debt restructuring transactions involving creditors, debtors, vendors and purchasers of target debtors ranging from amendments to existing credit agreements or arrangements to more complex debt restructuring and reorganization transactions. It is important that debt restructuring transactions or plans be reviewed from a tax perspective before being implemented. For example, what could be considered simple amendments to an existing credit agreement may give rise to unexpected adverse tax consequences under the Income Tax Act (Canada) (the “Act”).

If a “commercial debt obligation” issued by a debtor is settled (or deemed settled) as part of a debt restructuring plan, this may give rise to adverse tax consequences for the debtor under the debt forgiveness and debt parking rules in the Act if all or any portion of a commercial debt obligation is forgiven. For the purposes of these rules, a commercial debt obligation includes both arm’s length and non-arm’s length debt and interest and non-interest bearing debt to the extent that interest was or would have been deductible under the Act.

Debt forgiveness may result in a reduction of the debtor’s tax attributes (e.g. non-capital losses and net capital losses) and/or in an income inclusion for the debtor. If a debt restructuring transaction is reviewed from a tax perspective before implementation, it may be possible to minimize the impact of the debt forgiveness and debt parking rules for the benefit of the debtor, creditor, vendor or purchaser of the target debtor.

Miller Thomson Analysis

Depending on the particular facts and circumstances, there are various debt restructuring techniques that may be implemented to minimize the impact of the debt forgiveness and debt parking rules. If certain conditions are met, a debtor could for example transfer a forgiven amount to a related party or could reorganize its structure to preserve valuable tax attributes and/or eliminate or reduce any income inclusion which could result from debt forgiveness. Some of these debt restructuring techniques are complex and require a detailed tax analysis of various factors that is beyond the scope of this article.

We note that the debt forgiveness and debt parking rules are not the only tax rules under the Act that may have a potential impact on debt restructuring transactions. A detailed review of these other tax rules should also form part of the tax analysis of debt restructuring transactions.

Members of our corporate and tax group have the expertise to provide advice on the implementation of debt restructuring transactions for Canadian and non-resident creditors, debtors, vendors and purchasers of target debtors. If you require advice in this regard, we would be pleased to meet with you to discuss your debt restructuring needs.