12 June 2013 External T.I. 2013-0490361E5 - Capital loss

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.

Principal Issues: 1. Whether a capital loss can be claimed on a worthless investment.
2. Whether interest income received and reported in income in a particular taxation year can be reversed.

Position: 1. Depends on the facts of the case. 2. No.

Reasons: See Response.

XXXXXXXXXX 2013-049036
J. Nichols

June 12, 2013

Dear XXXXXXXXXX:

RE: Capital loss

We are writing in reply to your email dated May 22, 2013 requesting our view whether a capital loss may be claimed as a result of a failed investment in an interest-bearing mortgage. You believe the investment is worthless and that you have become an innocent victim of a fraud or scam. You also want to know whether the amounts you previously received and reported as interest income for income tax purposes may be removed from your income for those taxation years.

Our Comments

Written confirmations of the tax implications inherent in particular transactions are provided by this Directorate where the transactions are proposed and are the subject matter of an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, "Advance Income Tax Rulings", dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca/formspubs/menu-e.html. Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required. Such review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year. Notwithstanding the foregoing, we are prepared to provide the following comments that may be of assistance.

The income tax consequences pertaining to a failed investment where a taxpayer is an innocent victim of a fraud or scam can only be determined following a complete review of all the relevant facts and circumstances of the particular situation, which as noted above, would normally take place after the particular taxpayer has prepared and filed its income tax return for the year. However, where an amount owing to a taxpayer (other than a debt owing in respect of the disposition of personal-use property) at the end of a taxation year has become a bad debt in that year, subsection 50(1) of the Income Tax Act (the "Act") provides a mechanism for recognizing the capital loss. Generally speaking, where the debt is established to have become bad and provided the taxpayer makes an election to have the rules in subsection 50(1) of the Act apply in respect of such a debt, there will be a deemed disposition of the debt at the end of that year for proceeds equal to nil and a reacquisition of the debt immediately thereafter at a cost equal to nil. Subject to a possible application of paragraph 40(2)(g)(ii) of the Act (which may deny the capital loss if the debt was not acquired for the purpose of gaining or producing income from a business or property) these rules will result in the bad debt being treated as a capital loss of the taxpayer for the particular taxation year with any future recovery of that debt being treated as a capital gain. Further discussions of the CRA's views with respect to capital debts that become bad are outlined in Interpretation Bulletin IT-159R3, "Capital Debts Established to be Bad Debts".

In addition, paragraph 20(1)(p) of the Act may allow an income deduction for a bad debt where the particular amount owing to the taxpayer has previously been included in the taxpayer's income. However, to the extent that the particular amount was actually received by the taxpayer paragraph 20(1)(p) would have no application since no amount that was previously included in the taxpayer's income would still be owing. There are also no provisions in the Act that would allow interest income previously received by a taxpayer (and included in income) to be removed from the taxpayer's income.

We trust that these comments will be of assistance.

Yours truly

Michael Cooke, C.P.A., C.A.
Manager
Business and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch