26 October 1987 Income Tax Severed Letter 5-3759 - [871026]

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

OCT 26 1981

M.D. Praulins (613)957-2103

Dear Sirs

XXXX

The case that you have presented to us is in contemplation of a proposed transaction and as such is therefore more properly a matter to be dealt with in the form of an advance income tax ruling. Please refer to our Information Circular No. 70-6R entitled Advance Income Tax Rulings enclosed herewith, for procedures to be undertaken in requesting an advance income tax ruling.

Nevertheless, based on the information that you have provided in your letter and during our telephone discussions, we are prepared to offer you our general comments.

Our Comments

In our view, when payments are made on a guarantee, a debt is created between the debtor and the guarantor. Upon payment of the debt, the guarantor becomes subrogated to the original creditor. In the process the guarantor steps into the shoes of the original creditor and acquires the same rights and remedies available to the original creditor, e.g., right to repayment, interest and reimbursement of costs, if any. If the debt acquired by the guarantor is subsequently determined to be a bad debt, subsection 50(1) of the Income Tax Act (the "Act") deems the debt to have been disposed of for nil proceeds, resulting in a capital loss. However, subparagraph 40(2)(g)(ii) of the Act deems the guarantor's capital loss for tax purposes to be nil where the guarantee was given for no consideration.

In our view, the income tax consequences for a XXXX member who honoured the guarantee to the Bank would appear to be the same as outlined in the above paragraph. The substitution of the debenture for the note does not change the outcome of the transaction.

However, where the member's loss from the disposition of the debt is deemed to be nil pursuant to paragraph 40(2)(g) of the Act, paragraph 3 of Interpretation Bulletin IT-159R2 entitled Capital Debts Established to be Bad Debts states that in these circumstances the taxpayer will not be required to establish that the debt is bad in the year of disposition of the debt. Therefore, if the member subsequently recovers all or a portion of the debt in the form of an eventual return of the members' capital in respect of the Debenture, he will not have a capital gain. A copy of IT-159R2 is enclosed for your information.

If you wish to obtain additional information on the matters discussed above, please refer to the Department's publication entitled Your 1986 T1 Guide for Capital Gains available from the Edmonton District Taxation Office.

We regret that our reply could not have been more favourable, and we trust that our comments have been of some assistance to you and the members of the XXXX.

Yours truly,

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch