8 February 1989 Income Tax Severed Letter 5-7110 - [Definition of Small Business Corporation - Section 248(1) of the Income Tax Act (the "Act") and Allowable Business Investment Loss ("ABIL") Paragraph 39(l)(c) of the Act]

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

Small Business and General Division R. Langevin (613) 957-2138

FEB - 8 1989

Dear Sirs:

Re: Definition of Small Business Corporation - Section 248(1) of the Income Tax Act (the "Act") and Allowable Business Investment Loss ("ABIL") Paragraph 39(l)(c) of the Act

This is in reply to your letter of November 21, 1988, concerning the above-captioned matter.

You have described a situation in which a taxpayer has guaranteed a bank debt of a Canadian controlled private corporation ("CCPC") in which he is a shareholder. Subsequently, the taxpayer is called upon by the bank to honour the guarantee but the taxpayer refuses and litigation ensues. The taxpayer does eventually make payment several years after bankruptcy of the CCPC.

You have asked for our interpretation of the Act as it applies to this situation with regards to the allowance of ABIL in these circumstances given that the CCPC was not a small business corporation within the period of twelve months of payment of the guarantee.

Our Comments

It is our view that in circumstances in which a taxpayer is required to honour his guarantee of a debt, he is considered to have acquired the debt at the time that the guarantee is honoured and his cost of the debt will be equal to the amount of payment made pursuant to the guarantee. Accordingly, in the case you have described, the taxpayer will be considered to have acquired the debt in the year in which payment is made. Assuming the debt from the corporation is uncollectible, the taxpayer would have disposed of the debt by virtue of subsection 50(1) of the Act and may have incurred a capital loss at the end of the year of payment. It is our view, that if a capital loss is incurred it would not qualify as ABIL inasmuch as the CCPC ceased operations more than twelve months prior to the incurrence of the capital loss with the result that the CCPC would not meet the requirements of the definition of a small business corporation as required by subparagraph 39(l)(c)(iv) of the Act.

It should be noted that where a taxpayer has loaned money at less than a reasonable rate of interest to a Canadian corporation of which he is a shareholder or has guaranteed the debts of such a corporation for no consideration, the loan or the guarantee will generally be considered not to have been given for the purpose of gaining or producing income. Any loss from such a loan or guarantee will be deemed to be nil by virtue of subparagraph 40(2)(g)(ii) of the Act. Notwithstanding the above, it is the Department's practice to allow a loss on such a loan or guarantee and not to treat it as being nil by virtue of subparagraph 40(2)(g)(ii) of the Act if certain conditions as described in paragraph 6 of IT-239R2 are satisfied.

Yours truly,

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