24 July 1987 Income Tax Severed Letter 5-3408 - [870724]

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.

XXXX

D. Lanos (613) 957-2125

July 24, 1987

Dear XXXX

This is in reply to your letter of April 8, 1987 concerning subsection 20(4) of the Income Tax Act (the "Act").

The situation in question involves the sale of a rental property in 1981 for sales consideration that included the assumption by the purchaser of an existing mortgage on that property. As a condition of transferring that mortgage from the vendor (owner) to the purchaser, the mortgagee required the vendor to provide a guarantee in respect of the payment of the mortgage by the purchaser. The purchaser defaulted on the mortgage payments; the mortgagee foreclosed on the property; and the vendor was required to pay to the mortgagee pursuant to the guarantee, an amount equal to the excess, at the date of foreclosure, of the amount outstanding on the mortgage over the fair market value of the mortgaged property at that date.

You have not stated whether the sales agreement between the above vendor (owner) and the defaulting purchaser contains a provision in respect of default whereby any amount paid to the mortgagee by the vendor (owner) pursuant to the above guarantee becomes a debt or other amount owing to the vendor (owner) by the defaulting purchaser. Neither have you submitted any other information or documentary evidence which would assist in establishing the existence of "an amount that is owing to a taxpayer" (the vendor (owner) in this case) upon the above default for purposes of the provisions of subsection 20(4) of the Act.

Based on the limited facts supplied with your letter, we have difficulty in seeing how the vendor (owner) could be entitled to a deduction under subsection 20(4) in this case. However, there is always a possibility that an examination of the contracts between the parties as well as all the facts and circumstances surrounding the above transactions could result in a more favourable answer. Should this be a transaction that has already occurred, then it is something that should, of course, be referred to the local District Taxation Office.

A portion of an uncollectible amount paid to honour such a guarantee may constitute a capital loss. For purposes of subparagraph 40(2)(g)(ii) of the Act, it is our view that the acceptance of a new mortgagor (the subsequently defaulting purchaser in this case) by the mortgagee so as to enable completion of the sale by the vendor (owner) would constitute adequate consideration given to, and received by, the vendor (owner) in respect of the above guarantee. Therefore, the deduction of a capital loss in respect of payments made by the vendor (owner) under that guarantee would not be precluded by subparagraph 40(2)(g)(ii).

In general, the treatment, for purposes of subsection 20(4) of the Act and capital gains purposes, of the respective portions of a bad debt which relate to previous capital cost allowance recapture and capital gains reported on the initial disposition of a depreciable capital property, as well as the treatment to be accorded to any amounts subsequently recovered on such bad debts, is discussed in paragraph 3 of Interpretation Bulletin IT-220R .

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch