Debt Forgiveness: Procedures and Forms Updated

In difficult times, activity concerning bankruptcies, consumer proposals and debt restructuring increases. If interest is, or would be, deductible to the debtor, then a debt is considered to be commercial in nature. When commercial debt is forgiven, the forgiven amount is given special tax treatment. CRA has recently updated two of its tax forms that deal with commercial debt.

The debt forgiveness rules are summarized by CRA on form T2154 Application of Designated Forgiven Debt Under Section 80. In essence, when a commercial debt is settled for less than its principal amount, the forgiven amount must be applied to reduce any losses that have been carried forward. Any amount remaining may be applied to reduce other amounts such as capital cost, cumulative eligible capital and adjusted cost bases of capital properties. If not designated, any unapplied forgiven amount will be included in income.

The forms that have just been updated are:

1. T2153 Designations with Respect to Forgiven Debt Under Paragraph 80(2)1

When you as the debtor settle more than one commercial obligation at the same time, use this form to designate the order the obligations were settled under the debt forgiveness rules. If the order is not designated then CRA will make the choice for you.

2. T2155 Alternative Treatment of Capital Gains Arising Under Section 80.03 on Settlement of Debt

When you as the debtor surrender certain capital properties you will be considered to have a capital gain from the disposition at that time. You can treat the capital gain as a forgiven amount for the purposes of the debt forgiveness rules. You have to designate the amount using this form, and file it with your income tax return for the tax year when the disposition occurred.

There are maximum amounts of designated forgiven debt allowed. Another form, T2156 Transfer Agreement for Transferer of Forgiven Debt Under Section 80.04, allows the debtor to transfer unapplied forgiven amounts to an eligible transferee, as agreed by both parties. An eligible transferee is a corporation or partnership to which the debtor is related.

These debt forgiveness rules from Section 80 of the Income Tax Act are explained in greater detail in EverGreen Explanatory Notes. The rules are complex, so please consult a tax professional for advice and guidance. Planning and preparation will improve any situation when there are difficult decisions to be made.

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