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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
In a hypothetical situation:
(1) Whether a shareholder debt is a bad debt and qualifies for the election under subsection 50(1) of the Act?
(2) Whether a capital loss incurred by one corporation on a debt owed to it by another corporation would be deemed by subparagraph 40(2)(g)(ii) of the Act to be nil?
(3) Are there any further administrative positions to IT-239R2 with respect to the application of subparagraph 40(2)(g)(ii) of the Act?
(4) Whether a company would be a small business corporation within the meaning assigned by subsection 248(1) of the Act for the purposes of paragraph 39(1)(c) if the "only assets during the past 12 months were a reasonable amount of accounts receivable" that is being collected?
Position:
(1) No.
(2) Yes.
(3) No.
(4) No.
Reasons:
(1) The situation described does not meet the position outlined in paragraph 10 of IT-159R3. The amount of the debt owing to the shareholder would not be eligible for the election under subsection 50(1) of the Act.
(2) In the situation described, the corporation experiencing the loss is not the parent of the other corporation, therefore subparagraph 40(2)(g)(ii) applies since the administration position in paragraph 6 of Interpretation Bulletin IT-239R2 is not met.
(3) Interpretation Bulletin IT-239R2 contains the only exceptions to the application of subparagraph 40(2)(g)(ii). XXXXXXXXXX
(4) Trade account receivables, which are held to meet current cash flow or current working capital requirements, generally would be considered used in an active business. Although trade receivables are generated by the business, the test is whether they were used in the business. In the situation described, the trade receivables remained outstanding for an extended period of time, therefore they are not used in carrying on an active business. Unless the company was a SBC within any time in the preceding 12 months, this fact alone would exclude it from being eligible for a business investment loss under paragraph 39(1)(c) of the Act.
XXXXXXXXXX 2001-009600
Randy Hewlett, B.Comm.
January 8, 2002
Dear XXXXXXXXXX:
Re: Interpretation Request: Bad Debts and Carrying on a Business
We are writing in response to your letter dated August 3, 2001, wherein you requested our opinion on the above-noted matter as it relates to subsection 50(1) of the Income Tax Act (the Act) in a hypothetical situation.
In your letter, you describe a situation in which an individual is the sole shareholder of two companies (Opco1 and Opco2), each of which is a Canadian Controlled Private Corporation (CCPC) as defined by subsection 125(7) of the Act. Both Opco1 and Opco2 are carrying on an active business. There are no inter-corporate shareholdings between Opco1 and Opco2. The decision has been made to stop operations for Opco1 and sell its operating assets and inventory. Opco1 still pays rent for a portion of some office space and has a part-time employee that works collecting outstanding accounts receivable. Opco1 has unsecured liabilities in excess of its assets. It owes the shareholder $120,000, Opco2 $140,000 and trade payables to arm's length parties of $90,000. The trade receivable balance that has not been collected from arm's length parties is $50,000.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R4, Advance Income Tax Rulings, dated January 29, 2001. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to provide the following comments on each of the issues you raised:
(1) Individual Election Pursuant to Subsection 50(1) of the Act.
You inquire whether the debt owing by Opco1 to the shareholder would be a bad debt and qualify for the election under subsection 50(1) of the Act, if a decision were made to repay trade creditors of Opco1 as opposed to the shareholder. In your view, it is up to the taxpayer to establish when a debt is bad. As such, if a taxpayer reasonably determines that he or she will "not recover the debt as a whole then it is bad at that time".
As noted in paragraph 10 of Interpretation Bulletin IT-159R3 Capital debts established to be bad debts, dated May 1, 1989, the time at which a debt becomes a bad debt is a question of fact, dependent upon the circumstances in each case. Generally, a debt will not be considered bad unless the creditor has exhausted all legal means of collecting it, or the debtor has become insolvent and has no means of paying it. A debt is considered bad for the purpose of subsection 50(1) of the Act, only when the whole amount is uncollectible or a portion of it has been settled and the remainder is uncollectible. Therefore, where only a portion of a debt can be considered uncollectible, this portion is not considered to be bad for the purpose of subsection 50(1) of the Act.
In your letter, you note that from a "technical perspective", any capital loss incurred by Opco2 on the debt owed to it by Opco1 would be deemed by subparagraph 40(2)(g)(ii) of the Act to be nil. You inquire whether there is an "administrative policy" that would permit this capital loss.
Paragraph 6 of Interpretation Bulletin IT-239R2 Deductibility of Capital Losses from Guaranteeing Loans for Inadequate Consideration and from Loaning Funds at less than a Reasonable Rate of Interest in Non-arm's Length Circumstances, dated
February 9, 1981, outlines the only situations and conditions under which the Canada Customs and Revenue Agency will not apply subparagraph 40(2)(g)(ii) of the Act. In the situation you describe, the debt owed to Opco2 would not meet the exceptions since Opco1 is not a subsidiary of Opco2
(3) Small Business Corporation
In your letter, you note that one of the requirements that must be met by the shareholder to claim a business investment loss under paragraph 39(1)(c) of the Act with respect to the debt owing from Opco1, is that the company be a small business corporation (SBC) as defined in subsection 248(1). You inquire if Opco1 would be a SBC if the "only assets during the past 12 months were a reasonable amount of accounts receivable" that is being collected.
The definition of a SBC in subsection 248(1) of the Act requires, in part, that all or substantially all of the fair market value of the assets of the corporation be attributable to assets that are used principally in an active business carried on primarily in Canada. In our view, the fact that an asset is a trade account receivable does not, in and by itself, indicate that it is used principally in an active business. Trade account receivables, which are held to meet current cash flow or current working capital requirements, are generally considered used in an active business. Although trade receivables are generated by the business, the test is whether they were used in the business. In the situation you describe, the trade receivables remain outstanding for an extended period of time. It is our view that they are not used in carrying on an active business. Therefore, unless the company was a SBC within any time in the preceding 12 months, this fact alone would exclude it from being eligible for a business investment loss under paragraph 39(1)(c) of the Act.
The Interpretation Bulletins noted above can be found on our website at http://www.ccra-adrc.gc.ca. We trust our comments will be of assistance to you.
Yours truly,
John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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