2 April 1998 Internal T.I. 9722066 - PROMISSORY NOTE -WHETHER PAYMENT OF DEBT?

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

		April 2, 1998

	Tax Audit Division	HEADQUARTERS
	Kitchener- Waterloo	Wm. P. Guglich
	Tax Services Office	(613) 957-2102

	Attention:  Gary Huememoeder
		972206

Promissory Note - Payment of Debt or Evidence of Debt?

This is in reply to the memorandum of August 14, 1997, from Kathie Cameron requesting our views as to whether a promissory note received by a taxpayer would be considered payment of a debt or evidence of a debt, for purposes of subsections 28(1) and 76(1) of the Income Tax Act ("the Act").

We understand that the deceased taxpayer sold her entire farming operation to her daughter and as part of the sale, cattle and feed inventory was transferred to the daughter in consideration of a promissory note in the amount of $XXXXXXXXXX. Shortly after the sale, the taxpayer died. The taxpayer's representative contends that the promissory note evidences an account receivable assumed by the deceased taxpayer on the sale of the inventory and, therefore, it qualifies as a right or thing for purposes of subsection 70(2) of the Act.

As indicated in paragraph 3 of Interpretation Bulletin IT-433R, when computing income using the cash method, paragraph 28(1)(a) of the Act requires that amounts be included in income when received or when deemed by the Act to be received. The meaning of the term received is not necessarily limited to those situations where the income was actually received in cash. Received has a broader meaning. For instance, an amount may be said to have been received when a security or other right or a certificate of indebtedness or other evidence of indebtedness is received in payment of a pre-existing debt of an income nature.

Whether a promissory note is considered to be payment of a debt and therefore absolute payment, or evidence of a debt such that it is conditional, is a question of fact. Although it is usually considered that a creditor has accepted a promissory note as conditional payment or as evidence of indebtedness, in the appropriate circumstances, the promissory note may be accepted as absolute payment and the debtor will be considered to have paid the debt. For instance, paragraph 8 of Interpretation Bulletin IT-77R states that a security will be considered to be received in absolute settlement of a debt if the creditor accepts the security at the risk of its being dishonoured with the only legal recourse being an action against the issuer for failure to honour the obligation.

In our view, the documentation you submitted does not support the position of the taxpayer's representative that the promissory note evidences an account receivable assumed by the taxpayer. On the contrary both the Bill of Sale and the Purchase and Sale Agreement refer to the promissory note as the consideration given for the transfer of the inventory. Since the promissory note was accepted as consideration for the transfer of the inventory, and given that none of the documents provide any remedy for non-payment, it appears that payment could only be enforced under the terms of the promissory note. Therefore, on the basis of the documents submitted, it is our view that the promissory note constitutes absolute payment and that the deceased taxpayer can be said to have received $XXXXXXXXXX (the amount of the promissory note) at the time of the sale of the cattle and feed inventory. Accordingly, pursuant to subsections 28(1) and 76(1) of the Act, the amount of the promissory note received in respect of the cattle and feed inventory should have been included in the taxpayer's income for the year of the disposition.

As regards rights and things, given our comments above, the promissory note in respect of the farm inventory could not constitute a right or thing within the meaning of subsection 70(2) of the Act. Although paragraph 11 of Interpretation Bulletin IT-212R3 states that where income is reported on the cash basis and an amount is owing to a taxpayer on the sale of livestock, the debt is a right or thing, it should be noted that the comments in the Bulletin only apply as regards a debt receivable (an "amount owing") which is of an income nature, as opposed to a capital property. As the promissory note was received as consideration for the inventory transferred and accepted as absolute payment, there is no amount owing on the sale of the cattle and feed inventory. Therefore the promissory note, in the amount of $XXXXXXXXXX, held by the deceased taxpayer was capital in nature at the time of her death.

P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

cc. John Oulton

Technical Publications
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