Is it possible to convert the debt owed to me by a corporation into shares of the same corporation?

Yes. Section 51 of the Income Tax Act provides lenders with the opportunity to exchange debt owed to them by a company for newly-issued shares of that same entity without being considered to have disposed of the debt, hence preventing occurrence of any capital gain or loss.

Not all of the liability held by the lender is required to be converted. The debt must be capital property and its terms must give the holder the right to make the exchange. If a conversion feature does not exist, it can generally be inserted into the debt without resulting in a disposition of the security.

Also, for section 51 to apply, only shares (and no cash) can be received as consideration by the holders in exchange for the debt. Once the capital properties are switched over, the cost of the new shares issued to the holders will be equivalent to the adjusted cost base of the debt given up.As well, the paid-up capital of the new shares will be reduced from their corporate state capital to equal the paid-up capital of the property given up.

Listed below are few examples of circumstances in which this provision would be useful:

• Company is facing liquidity problems.
• Hold convertible debt already.
• Improve balance sheet health by reducing debt and increasing share capital.
• Want to sell company which has a lot of shareholder debt that buyers do not want to assume.

ABOUT THE AUTHOR

ALLAN MADAN

CA.CPA.CGA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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