Debt forgiveness rules: losses cut first, half the rest is income

In what order does section 80 apply the forgiven amount?

Section 80 applies the forgiven amount in a fixed sequence: subsections 80(3) to 80(5) and 80(8) to 80(13) run in numerical order, and each step only gets what the earlier steps left laws-lois.justice.gc.ca. The loss steps are automatic. The asset steps happen only to the extent your client designates them on Form T2154, filed with the return for the year the debt is settled canada.ca.

The "applicable fraction" in step 2 is the inclusion rate that section 38 used for the loss year, and the forgiven amount consumed is the loss reduction divided by that fraction under 80(2)(e) laws-lois.justice.gc.ca. For a loss year at the current 50% inclusion rate, $1 of forgiven amount erases $0.50 of net capital loss.

Step 7 is not free. An amount designated under 80(11) comes back in the 80(13) formula (variable B), capped at the residual balance of tax attributes held by directed persons, so it can still be taxed laws-lois.justice.gc.ca.

How does a $500,000 loan settled for $200,000 put $45,000 into income?

OpCo owes an arm's length lender $500,000 on a business loan and settles it for $200,000 cash. The forgiven amount is $300,000. OpCo has $120,000 of non capital losses (none from an ABIL), a $20,000 net capital loss from a 50% inclusion year, $50,000 of class 8 UCC that it chooses to designate, and no current year capital losses.

The 80(4) line is where most working papers go wrong. Half of the $180,000, or $90,000, was available to reduce net capital losses, but OpCo only had $20,000, and wiping that out used $40,000 of the forgiven amount ($20,000 ÷ 1/2).

If OpCo is solvent, the $45,000 can go into a 61.4 reserve of at most four fifths in the settlement year, three fifths the next, then two fifths and one fifth, so at least $9,000 is taxed in year one and the full $45,000 by year five laws-lois.justice.gc.ca. Designating the UCC was optional: leave it alone and the $90,000 left would have been $140,000, putting $70,000 into income instead of $45,000 while keeping $50,000 of future CCA.

Which debts does section 80 catch, and how is the forgiven amount measured?

Only a commercial obligation. A commercial debt obligation is one where interest paid or payable under a legal obligation was, or would have been, deductible to the debtor, so an interest free shareholder loan used in the business still qualifies laws-lois.justice.gc.ca. A debt for personal purposes, where interest would never be deductible, is outside section 80. So is an excluded obligation, such as one whose proceeds were already included in income or deducted from the cost of property.

The forgiven amount is the lesser of the amount the debt was issued for and its principal, minus twelve items listed in the definition. The ones you meet most are the amount paid to settle the principal, and any amount taxed to someone else under 6(1)(a) or 15(1) because of the settlement laws-lois.justice.gc.ca. That second item is why a debt forgiven to a shareholder is taxed once, under 15(1.2) as a shareholder benefit, and not again under section 80 laws-lois.justice.gc.ca.

Four rules in 80(2) change the measurement. Unpaid interest that was deducted is its own obligation, so forgiving accrued interest creates a forgiven amount too (80(2)(b)). Shares issued to settle a debt count as paid at their fair market value (80(2)(g)). Any increase in the value of shares the creditor already owns counts as paid (80(2)(g.1)). Debts settled at the same time are applied in the order the debtor designates (80(2)(i)) laws-lois.justice.gc.ca.

Section 80 can apply with no formal settlement at all. A commercial debt owed to an unrelated creditor is deemed settled when it becomes statute barred under 80.01(9), and a debt bought by a non arm's length holder for less than 80% of its principal is a parked obligation deemed settled under 80.01(8), with the purchase price treated as the amount paid laws-lois.justice.gc.ca.

How much of the 80(13) inclusion can 61.3 and 61.4 remove?

An insolvent corporation resident in Canada throughout the year deducts under 61.3 the lesser of its 80(13) inclusion and A − 2(B − C − D − E). A is the inclusion, B is the fair market value of assets at year end plus income tax paid for the year and amounts distributed to non arm's length persons in the last 12 months, C is total liabilities (excluding those taxes), D is distress preferred shares, and E is 50% of other income for the year above the inclusion laws-lois.justice.gc.ca.

The deduction keeps twice the net asset surplus in income. The $20,000 left can still go to a 61.4 reserve, because the reserve base is the 80(13) inclusion minus 61.3 deductions, so up to $16,000 (four fifths) waits until the next year laws-lois.justice.gc.ca. The 61.4 reserve is open to a corporation or trust resident in Canada throughout the year and to a nonresident with a fixed place of business in Canada, and it drops to nil in a year the corporation starts winding up, unless 88(1) applies.

Claiming 61.3 has a cost: if your client didn't designate under 80(5) to 80(11) as far as possible, 80(16) lets the CRA make those designations instead laws-lois.justice.gc.ca. An individual uses 61.2, which can deduct the whole inclusion when income is $40,000 or less and leaves 20% of income above $40,000 taxable laws-lois.justice.gc.ca.

What does the settlement change on the T2?

The forgiven amount that reduces losses goes on Schedule 4: line 140 for non capital losses, line 240 for capital losses, line 340 for farm losses and line 440 for restricted farm losses, each in the order section 80 sets canada.ca. See non capital loss carryover and net capital loss carryover for the continuity itself.

An 80(5) designation shows on Schedule 8: a capital cost reduction comes off acquisitions in column 3, and a UCC reduction for the class comes off in column 6 canada.ca.

File Form T2154 with the return for the settlement year or the designation is not valid, and with no T2154 the unapplied amount goes to 80(13). Add Form T2153 when two or more obligations are settled at the same time, and Form T2156 to transfer a forgiven amount to a related company under section 80.04 canada.ca. The current T2154 is the 2009 version and still has a section for cumulative eligible capital under 80(7); that subsection is repealed, so leave that part blank and put goodwill reductions through class 14.1 under 80(5) canada.ca.

Does a bankruptcy still switch section 80 off?

Under the Act as consolidated to September 21, 2026, yes: item (i) of the forgiven amount definition subtracts the full principal when the debtor is a bankrupt, so the forgiven amount is nil laws-lois.justice.gc.ca. No losses are ground down and nothing goes into income.

The CRA treats the planning version as reportable. NT-2023-03, effective November 1, 2023, is a notifiable transaction where a debtor is assigned into bankruptcy, the debt is settled while it's bankrupt, and the bankruptcy is later annulled after a proposal under Part III of the Bankruptcy and Insolvency Act canada.ca. See mandatory disclosure rules for the RC312 filing.

Budget 2024 proposed to repeal the bankruptcy exception for corporations for bankruptcy proceedings starting on or after Budget Day, keeping it for individuals; a bankrupt corporation would then rely on the 61.3 deduction instead budget.canada.ca. As of October 2026 that change is not in the consolidated Act, so check its status before you rely on the exception for a corporate bankruptcy that started after Budget Day 2024.