20 September 1990 Ministerial Correspondence 900904 F - Deductibility of Bad Debts

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.

September 20, 1990

Dear Sirs:

Re:  Advance income tax ruling request

As advised in our telephone conversation of June 28, 1990, we are unable to provide the ruling requested in your letter of May 15, 1990, as we do not provide advance rulings on completed transactions or on the question of whether a gain or loss is on income or capital account.  We will ask the Saint John District Taxation Office to address your concerns with respect to the completed transactions.  In addition, we offer the following general comments on the various issues raised inyour request which may be of assistance to you.

Loss on Debt Receivable

Whether a taxpayer's loss on a debt receivable is an income loss or a capital loss is a question that can only be ascertained after a review of all the relevant facts.  In the case of a debt which arose from a loan made by a taxpayer, subparagraph 20(1)(p)(ii) of the Income Tax Act (the "Act")authorizes a deduction of:

     all amounts each of which is that part of the amortized cost to the taxpayer at the end of the year of a loan ... made ... in the ordinary course of business by a taxpayer ... whose ordinary business included the lending of money established by him to have become uncollectable in the year

Interpretation Bulletin IT-442 discusses the tax treatment of bad debts and reserves for doubtful debts.  Paragraphs 10 and 11 of that bulletin contain a brief discussion of the circumstances in which a taxpayer's ordinary business includes the lending of money.  There is also a significant body of jurisprudence on this topic; see for example the list of court cases cited in the editorital comment commencing at paragraph 5103 of the CCH Canadian Limited Topical Law Reports.

If a taxpayer's ordinary business does not include the lending of money the loss would be deductible under subsection 9(2) only if it is an ordinary expense in the determination of the profit from the business (see paragraph 8 of IT-442).

For purposes of subdivision c of the Act (taxable capital gains and allowable capital losses), subsection 50(1) of the Act deems a debt which has become a bad debt in a taxation year to have been disposed of at the end of that year.  A loss resulting from that deemed disposition is deemed to be nil by the provisions of subparagraph 40(2)(g)(ii) of the Act unless the debt had been acquired by the taxpayer for the purpose of gaining or producing income from a business or property.  If the exception in subparagraph 40(2)(g)(ii) of the Act is met, the capital loss arising on the deemed disposition would qualify as a business investment loss only if the requirements in paragraph 39(1)(c) of the Act were met.

Deductibility of Losses upon a Change in Control

Where control of a corporation has been acquired by a person or group of persons, paragraphs 111(4)(a) and 111(5)(a) of the Act, set out the rules regarding the deductibility of losses carried forward.  In general terms, these provisions state that net capital losses cannot be deducted and non-capital losses may be deducted only if the particular business which gave rise to the loss is carried on by the corporation for profit or with a reasonable expectation of profit throughout the particular year and then only to the extent of the aggregate of the corporation's income for the particular year from that business.  Property losses and allowable business investment losses cannot be carried forward following a change in control.  You may wish to refer to IT-302R2 for further information.  In particular, note the discussion in paragraph 4 of the bulletin of situations where control of a corporation is deemed not to have been acquired for purposes of section 111 of the Act.

Acquisition of Shareholder Loans from Former Shareholders

In accordance with paragraph 12 of IT-239R2, where the person or persons (the "Acquirors") acquiring the shares of a corporation also acquire loans owed to the the disposing shareholders by the corporation (the "Loans") for an agreed amount less than the Loans' principal amounts, the cost of the Loans to the Acquirors will equal the disposing shareholders' proceeds therefrom.

Whether the Acquirors would realize an income gain or a capital gain on amounts paid to them by the corporation in respect of the Loans can only be ascertained after a review of all relevant facts.  In a number of court cases such gains were held to be on income account.  See for example:

(1)      William A. Perkins v. Her Majesty the Queen, 80 DTC 6154 (F.C.A.)

(2)      Her Majesty the Queen v John Woods, 77 DTC 5411 (F.C.-T.D.)

(3)      Stephen S. Steeves v. Her Majesty the Queen 77 DTC 5230 (F.C.A.)

(4)      Minister of National Revenue v. James N. Sissons 69 DTC 5152 (S.C.C.)

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate