5 June 1991 Internal T.I. 9106827 F - Jurisprudence Regarding Consitution of a Loan in the Ordinary Course of Business

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.

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This is in response to your memorandum of March 1, 1991, regarding a proposed reassessment of the above-noted taxpayer.

FACTS

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ANALYSIS

As indicated in your memorandum, the jurisprudence regarding what constitutes a loan made in the ordinary course of business depends upon the particular facts in each case.  After reviewing the cases cited by you, as well as others relating to bad debt provisions (see appendix), we believe the following elements are considered to be indicative of a money lending business:

1.      An integral part of the taxpayer's business must be earning income from lending money (K.J. Beamish Construction Ltd. v. MNR, [1990] 2 CTC 2199 (TCC), Wesco Property Developments Ltd. v. MNR, [1989] 2 CTC 2431 (TCC)).

2.     The taxpayer should intend to earn income from direct interest payments, not through indirect extra sales, enhancement of value of an investment or dividends (Morflot Freightliners Ltd. v. The Queen, [1989] 1 CTC 413, (FC-TD), Charles Chaffey v. MNR, 78 DTC 6176 (FCA), K. J. Beamish Construction Ltd. (supra)).

3.     The taxpayer should be able to establish a systematic and continuous pattern of lending money (The Queen v. Pollock Sokoloff Holdinqs Corp., 74 DTC 6321 (FC-TD)) and the loan(s) in question should fit into the established pattern (The Queen v. E.V. Keith Enterprises Ltd., 76 DTC 6018 (FC-TD), Charles Chaffey (supra), Jack Dichter Developments Ltd. v. MNR, 79 DTC 608, (TRB)).

4.     Advances to and investments in subsidiary corporations by the parent company will generally be considered to be advances of working capital and are of a capital nature (K.J. Beamish Construction Ltd. (supra), Stewart & Morrison Ltd. v. MNR, 72 DTC 6049, (SCC), N.M. Tilley Realty Ltd. v. MNR, 84 DTC 1343 (TCC), Morflot Freightliners Ltd. v. The Queen, (supra)).  Similarly, payments in respect of guarantees are generally considered to be expenditures of a capital nature, the deduction of which is prohibited by paragraph 18(1)(b) of the Act (The Queen v. MerBan Capital Corporation Limited,[1989] 2 CTC 246, (FCA)).

5.     The mere fact that the borrower is a subsidiary of the lender corporation does not preclude the lender from making a loan in the ordinary course of its business (Highfield Corporation Ltd. v. MNR, [1982] CTC 2813 (TRB)), but in such a situation, the parent corporation's ordinary course of business must consist of making loans (Highfield Corporation Ltd. (supra), Wesco Property Developments Ltd. (supra)).

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We appreciate the thoroughness of your memorandum to us, both in  terms of providing us with a detailed background of the facts and  a well-researched and thoughtful analysis of the law.  We trust  that our foregoing comments are satisfactory and helpful.

for DirectorFinancial Industries Division Rulings Directorate

APPENDIX

CASES CONSIDERED

Morflot Freightliners Ltd. v. The Queen, [1989] 1 CTC 413, (FCTD)

Canadian parent advanced funds to a U.S. subsidiary in order to provide the subsidiary with working capital.  The taxpayer was not in the money lending business.  The U.S. subsidiary failed and the taxpayer attempted to deduct, as a current expense under paragraph 18(1)(a) of the Act, the monies advanced to the subsidiary.  The court found that the monies advanced to the subsidiary were capital in nature, in that the parent was attempting to preserve for its advantage an enduring benefit, not for the direct and immediate gaining of profit through sales or the earning of commissions.

The Queen v. Pollock Sokoloff Holdinas Corp., 1974 DTC 6321 (FCTD)

X Co. loaned $50,000 to Mr. X. Subsequently, X Co. and the defendant transferred assets, including the $50,000 loan, to the defendant taxpayer.  The defendant attempted to deduct $30,000 of the loan as a bad debt.  The $50,000 original loan bore interest and was, in part, secured by shares.  The court found that the taxpayer was in the money lending business as one of the taxpayer's purposes was to lend money.  The taxpayer had a history of lending money in a systematic and continuous way and the taxpayer acted in a prudent manner in charging interest and acquiring security. The loan in question was similar in nature to previous loans.  The taxpayer had satisfied the court that there was a bad debt under paragraph 20(1)(p) of the Act.

MNR v. Steer, [1966] CTC 731 (S.C.C.)

Taxpayer guaranteed a company's indebtedness.  In return for the guarantee, the taxpayer received shares in the company.  The taxpayer was required to honour the guarantee.  It tried to deduct the guarantee on income account.  The court held that the guarantee amount was a capital outlay.  The transaction was a deferred loan to the company.

The Queen v. MerBan Capital Corporation Limited, [1989] 2 CTC 246 (FCA)

In a complicated transaction, the taxpayer made interest payments pursuant to either a guarantee or indemnity agreement between itself and two subsidiaries; the subsidiaries themselves were incorporated solely to acquire the shares of an operating company. The taxpayer attempted to deduct the interest payments under paragraph 20(1)(c) of the Act.  The Court held that, if the interest payments were paid pursuant to a guarantee, the payments were not deductible because the guarantee was capital in nature.

Paragraph 18(1)(b) of the Act prohibited the deduction of the interest paid pursuant to the guarantee.  If the payments were paid pursuant to an indemnity agreement, the payments were not deductible pursuant to paragraph 20(1)(c) of the Act as the subsidiaries, not the taxpayer had borrowed the money.

The Queen v. E.V. Keith Enterprises Ltd., (1976] DTC 6018 (FCTD)

The taxpayer was a management and investment company which had, historically, loaned money to individuals and firms it did business with.  The court found that the taxpayer had established over the years a pattern of both loaning money and carrying deferred balances to accommodate persons and companies doing business with the operating entities through which its construction and other activities were carried on.  The taxpayer loaned $15,000 to a nephew of the major shareholder.  The nephew was involved in the same type of business as the taxpayer.  The nephew was unable to repay the debt and the taxpayer sought to deduct it under paragraph 20(1)(p) of the Act.  Interest was charged on the loan.  The loan was of the type and to a person (family member) that the taxpayer had established a pattern of making.  The bad debt expense was allowed.

Charles Chaffey v. MNR, 1978 DTC 6176 (FCA)

The taxpayer, in partnership with another, held shares in a company formed to operate a tourist attraction.  The partnership also advanced funds by way of loans to the company.  When the company's business proved unsuccessful, the partnership sold half the shares in the company and half of the indebtedness.  The indebtedness was sold at a loss and the taxpayer sought to deduct the loss as a bad debt pursuant to paragraph 20(1)(p) of the Act.  The taxpayer was not in the money lending business.  Though the taxpayer had a history of making shareholder loans to a company, this was a means of financing; its principal purpose was not the accommodation of persons in return for income in the form of interest; the loans were financing of projects through which profit was to be made by other means.  Accordingly, the taxpayer was not in the business of lending money and the appeal was dismissed.

N.M. Tilley Realty Ltd. v. MNR, (l984] DTC 1343 (TCC)

Taxpayer corporation was engaged in selling real estate.  It often loaned money to its clients.  The taxpayer also loaned money (non-interest bearing) to two companies formed by the taxpayer to build and sell residential homes; additionally, it guaranteed bank loans to the two companies.  The companies failed and the taxpayer sought to deduct both the loans and guarantees as a bad debt.  The court found that the loans and guarantees were capital outlays - being the provision of operating capital.  The advances, being capital in nature did not fall into the taxpayer's ordinary course of business and were not similar to its other loans.

Dutch-More Corporation v. MNR, [1981] CTC 2023 (TRB)

The taxpayer, through a related company, was owed $65,000 by a trade customer.  After come discussion, the $65,000 was turned into a loan.  The trade customer was unable to repay the monies. The taxpayer sought to deduct the $65,000 as a bad debt.  The taxpayer was not in the money-lending business.  It had no pattern.  The only other loan in evidence was to a relative and non-interest bearing.  Moreover, one has to look at the nature and purpose of the loans, not the number.  The loan was not a trade debt as the debtor was already insolvent, thus the loan was capital in nature.

Highfield Corporation Ltd. v. MNR, [1982] CTC 2813 (TRB)

Taxpayer had a history of making loans by way of investment in companies.  The court found that the investment activities of the taxpayer constituted a business and that the two loans in question were made in the ordinary course of business.  The loans were interest bearing, although the larger profit was expected to be realized by way of dividends.  The court found that, notwithstanding the expected return from dividends, the loans themselves and the interest they bore constituted a profit generating activity.  The fact that the loans were between a parent and subsidiary was not relevant.  The taxpayer was in the business of lending money, the loans in question followed the usual course of the taxpayer's money-lending activities and the taxpayer was eligible for the deduction under paragraph 20(1)(p) of the Act.

Stewart & Morrison Ltd. v. MNR, (1972] DTC 6049, (SCC)

The Canadian parent company arranged and guaranteed loans to a U.S. subsidiary; the Canadian taxpayer also made advances to the U.S. subsidiary.  The money was used to pay operating expenses. The money advanced to the U.S. subsidiary was capital in nature and not deductible under paragraph 18(1)(b) of the Act.  There was no argument under paragraph 20(1)(p) of the Act.

Wesco Property Developments Ltd. v. MNR, [1989] 2 CTC 2431 (TCC)

The taxpayer, a land development company, had a history of entering into arrangements with various entities whereby it both developed land and loaned money in various forms to the entities.  The loans bore interest and were an important part of the appellant's profit-making process.  There was the required degree of system and continuity.  There was an expectation of interest. The loans in question were clearly related to the business and profit earning process of the taxpayer.  Stewart & Morrison was inapplicable because that case only dealt with a loss under (now) paragraph 18(1)(a) of the Act and paragraph 18(1)(b) of the Act.

Jack Dichter Developments Ltd. v. MNR, (1979) DTC 608. (TRB)

The taxpayer was incorporated and one of its objects was the making of loans. However, a loan to a non-arm's length party was not consistent with the pattern of loan making previously established by the taxpayer and, therefore, the loan could not be said to be in the taxpayer's ordinary course of business.

K.J. Beamish Construction Ltd. v. MNR, [1990] 2 CTC 2199 (TCC)

The corporate taxpayer was involved in real estate development.  It got involved in a transaction whereby it purchased shares in a development company, made advances as necessary to the company and honoured a guarantee to a bank after the company defaulted. The court found that the acquisition of shares in the company was an investment with the intention of earning dividends. Per: Stewart & Morrison, the advances were to provide working capital and were capital in nature. Per: Steer, the guarantee paid was also on capital account.  In contrast to Westco, the loans had no interest rate and, accordingly, could not be said to be capable of earning a profit, a major indication of a business.  Therefore, there was no business of lending money.