22 July 2003 Internal T.I. 2003-0024377 - ABIL-POST BANKRUPTCY RETURN

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: Whether an allowable business investment loss is deductible in computing the income reported on an individuals post-bankruptcy return under paragraph 128(2)(f) of the Act.

Position: No.

Reasons: The individual taxpayer would not be entitled to deduct the allowable business investment loss or any resulting non-capital loss on his post-bankruptcy returns. In computing the income for the year to be reported on the post-bankruptcy return subparagraph 128(2)(f)(ii) of the Act denies the deduction of any loss incurred by the trustee through dealings in the estate of the bankrupt or in carrying on the business of the bankrupt. In addition, subparagraph 128(2)(f)(iii) of the Act denies the deduction of any amount under section 111 of the Act.

							July 22, 2003

	Susanna Cheung				HEADQUARTERS
	Toronto North Tax Services Office	Karen Power, CA
(613) 957-8953

							2003-002437

Allowable Business Investment Loss - Bankrupt Individual

We are writing in reply to your email of June 11, 2003 regarding the above-noted subject matter. You enquire whether an individual would be entitled to carry forward a non-capital loss to a post-bankruptcy return filed under paragraph 128(2)(f) of the Income Tax Act (the "Act").

The facts as we understand them are as follows:

1. The taxpayer declared bankruptcy on XXXXXXXXXX. To date the taxpayer has not been discharged absolutely from bankruptcy.

2. The taxpayer owes approximately $XXXXXXXXXX to various creditors, including approximately $XXXXXXXXXX owing to the Canada Customs and Revenue Agency. The debts are the result of loan guarantees on properties owned by a corporation (the "Corporation") XXXXXXXXXX% owned by the taxpayer.

3. The taxpayer's bankruptcy trustees took over the Corporation and all assets were seized. The Corporation was dissolved effective XXXXXXXXXX. The Corporation owed the taxpayer approximately $XXXXXXXXXX.

4. The taxpayer filed an amended T1 return for the XXXXXXXXXX taxation year claiming a business investment loss with respect to the $XXXXXXXXXX owed to him by the Corporation.

5. Since XXXXXXXXXX, the taxpayer has been reporting consulting income on his post-bankruptcy returns filed under paragraph 128(2)(f) of the Act. The consulting income was received from a corporation XXXXXXXXXX % owned by the taxpayer's XXXXXXXXXX. For years after XXXXXXXXXX, the taxpayer has been offsetting the consulting income with loss carryforwards resulting from the business investment loss described above.

You enquire as to the timing of the business investment loss and whether any resulting non-capital loss may be deducted on the taxpayer's post-bankruptcy returns.

Our Comments

A taxpayer's business investment loss as defined in paragraph 39(1)(c) of the Act may arise from the disposition of a share of a corporation that is a small business corporation or from the disposition of a debt owing to the taxpayer by a Canadian-controlled private corporation. The disposition must be to an arm's length person or be deemed to have occurred under subsection 50(1) of the Act (as discussed below).

Where a debt is owed by a Canadian-controlled private corporation, the corporation must be:

- a small business corporation;

- a bankrupt (as defined by the Bankruptcy and Insolvency Act) that was a small business corporation when it last became a bankrupt; or

- a corporation referred to in section 6 of the Winding-up and Restructuring Act that was insolvent (within the meaning of that Act) and was a small business corporation at the time a winding-up order under that Act was made in respect of the corporation.

Based on the limited information provided to us, we cannot determine whether any of these requirements have been met, particularly whether the Corporation was at any time a small business corporation, as defined in subsection 248(1) of the Act. Where an election under subsection 50(1) of the Act is made, a taxpayer is deemed to have disposed of a debt at the end of a taxation year for nil proceeds and to have reacquired it immediately thereafter at a cost of nil if, in the case of a debt (other than a debt from the sale of personal use property), the debt is owing to the taxpayer at the end of the taxation year and it is established by the taxpayer to have become a bad debt in the year. If subsection 50(1) applies, the taxpayer is deemed to have disposed of the property for nil proceeds and a capital loss may arise. The time at which a debt becomes a bad debt is a question of fact and any decision made will be dependent upon the circumstances in each case. A determination by a creditor that a debt has become bad in a particular taxation year must be supported by all relevant and material facts. Generally, a debt will not be uncollectible at the end of a particular taxation year unless the creditor has exhausted all legal means of collecting it or where the debtor has become insolvent and has no means of paying it. A debt is considered bad for the purpose of section 50 of the Act only when the whole amount is uncollectible or when a portion of it has been settled and the remainder is uncollectible. In the situation described above, we have not been provided with sufficient information to determine when the taxpayer's debt became bad.

In the calendar year in which an individual becomes bankrupt, a number of income tax returns must be filed by, or on behalf of, the individual:

- a return to be filed for the taxation year that ends on the day before the bankruptcy (the "pre-bankruptcy return");

- a return to be filed under paragraph 128(2)(e) by the trustee in bankruptcy with respect to certain income of the estate and business for each taxation year ending in the calendar year; (the "in-bankruptcy return") and

- a separate return to be filed under paragraph 128(2)(f) by the individual for the taxation year that begins on the day of bankruptcy (the "post-bankruptcy return").

For each subsequent calendar year during which the individual is bankrupt, the trustee and the individual must continue to file income tax returns in respect of the income of the individual. That is, the trustee must file in-bankruptcy returns and the individual must file post-bankruptcy returns.

The income for purposes of the in-bankruptcy return filed by the trustee is to be calculated as if the only income of the individual for the particular taxation year were the income for the year, if any, "arising from dealings in the estate of the bankrupt or acts performed in the carrying on of the business of the bankrupt by the trustee." The income for purposes of the post-bankruptcy return filed by the individual would include all post-bankruptcy income of the individual that is not reported on the in-bankruptcy return filed by the trustee. You have indicated during a recent telephone conversation (Cheung/Power) that the consulting income received by the taxpayer was unrelated to his bankrupt business; consequently we would agree that such income was properly reported on the taxpayer's post-bankruptcy returns, however we are not in a position to comment on the reasonableness of the amount received.

Should you determine that the taxpayer's debt became bad after the date of bankruptcy, any resulting allowable business investment loss would be deductible in computing the taxpayer's income for the year to be reported on the in-bankruptcy return filed by the trustee. The allowable business investment loss would, in our view, arise from dealings in the estate of the bankrupt. Any resulting non-capital losses would be deductible in computing the taxpayer's taxable income for future in-bankruptcy returns pursuant to clause 128(2)(e)(ii)(B) of the Act. Similarly, clause 128(2)(e)(ii)(B) of the Act would permit the deduction, to the extent provided under section 111 of the Act, of losses in respect of any taxation year that ended before the bankruptcy (in circumstances where you conclude that the taxpayer's debts became bad prior to bankruptcy).

We agree with your analysis, that the taxpayer would not be entitled to deduct the allowable business investment loss or any resulting non-capital losses on his post-bankruptcy returns. In computing the income for the year to be reported on the post-bankruptcy return, subparagraph 128(2)(f)(ii) of the Act denies the deduction of any loss incurred by the trustee through dealings in the estate of the bankrupt or in carrying on the business of the bankrupt. In addition, subparagraph 128(2)(f)(iii) of the Act denies the deduction of any amount under section 111 of the Act.

For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust our comments will be of assistance.

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch