17 November 1986 Income Tax Severed Letter 7-0802 - [Allowable Business Investment Losses]

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.

NOV 17 1986

Rulings Directorate M. Siegel 957-2746

Allowable Business Investment Losses

This is in reply to your memorandum of July 2, 1986 to which you have attached a copy of a memorandum from the Vancouver District Office. We regret the delay in responding.

You are concerned as to the characterization for tax purposes of interest paid on money borrowed to honour a loan guarantee when the business to which the loan was originally made ceases to operate and the guarantee was given for no consideration.

When payments are made on a guarantee a debt is created between the guaranteed party and the guarantor. When this debt is determined to be bad subsection 50(1) of the Income Tax Act deems the debt to have been disposed of for nil proceeds, creating a capital loss. Subparagraph 40(2)(g)(ii) of the Act, however, deems the capital loss to be nil where the guarantee was given for no consideration.

The Department has created an exception to this general rule in Interpretation Bulletin IT-239R2 . Where the conditions set out in paragraph 6 of this Bulletin are satisfied, even where a guarantee is given for no consideration, payments on the guarantee (covering both principal and interest) which are subsequently considered bad debts will give rise to deductible capital losses due to the application of subsection 50(1) of the Act and the administrative non-application of subparagraph 40(2)(g)(ii) of the Act. These capital losses may be considered business investment losses pursuant to paragraph 39(1)(c) of the Act. The Department has also created an exception to the requirements of paragraph 20(1)(c) of the Act in Interpretation Bulletin IT-445 . Where the conditions set out in paragraph 9 of this Bulletin are satisfied interest payments on money borrowed to honour a loan guarantee will be deductible pursuant to paragraph 20(1)(c) even where the guarantee was given for no consideration. It is indicated, however, in paragraph 4 of this Bulletin, that interest will cease to be deductible pursuant to paragraph 20(1)(c) when the corporation whose loan was guaranteed ceases to operate its business. This position is supported by the decisions in Alexander v. M.N.R., 83 DTC 459, and Lyons v. M.N.R., 84 DTC 1633.

Therefore, in response to the issues raised by you we submit the following:

1. When a taxpayer honours a guarantee for a Canadian controlled corporation he may be allowed a capital loss for payments made under the guarantee, which may include accrued interest on the corporate debt up to the date the corporation ceased operations.

2. As indicated previously an allowable business investment loss may arise with respect to this capital loss, but only when the debt created by honouring the guarantee becomes bad, which usually arises when the corporation ceases operations.

3. Refer to paragraphs 1 and 2 above.

4. It is our opinion that the factual situation which resulted in a capital loss in the case of Bowater Canadian Limited v. The Queen, 86 DTC 6070, is clearly distinguishable from the situations outlined in Interpretation Bulletins IT-239R2 and IT-445 . In the noted Bulletins guarantees were given for no consideration to corporations in which the guarantor had an interest. While it is admitted that Bowater and its co-venturer guaranteed for no consideration the debts of Bulkley Valley, they were never called upon to honour this guarantee. When Bowater and its co-venturer sold Bulkley Valley a refinancing took place, pursuant to which the debts originally guaranteed by Bowater were replaced by Series B Notes, which were also guaranteed by Bowater and its co-venturer. It must be assumed from the facts of the case that the sale would not have taken place if Bowater had not given this second guarantee, and it was on this latter guarantee that Bowater was called upon to make payments, first to the banks and then to its co-venturer. These payments (which included interest on borrowed money) created debts which could not be recovered on, and would be deemed to be disposed of for nil proceeds pursuant to subsection 50(1) of the Act. The resulting capital loss would not be denied by virtue of subparagraph 40(2)(g)(ii) of the Act since the debt was acquired as consideration for the disposition of capital property (the shares and obligations of Bulkley Valley) to a person with whom the taxpayer was dealing at arm's length (Northwood). While this case supports the proposition that interest on money borrowed to honour a guarantee is deductible as a capital loss, it is based on the specific facts of this case, that is where the guarantee resulted from the sale of the guaranteed business. Since the factual circumstances are different we are not obliged to concern ourselves as to whether the Court would have come to the same conclusion in the situation outlined in Interpretation Bulletin IT-239R2 , and, therefore, we need not consider the Court's decision as being applicable in that situation.

Director Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch