31 July 1992 External T.I. 9119185 F - Loan Guarantees

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.

Attention:  19(1)

July 31, 1992

Dear Sirs:

Re:     Loan Guarantees

We are writing in response to your letter, dated July 9, 1991, in which you requested our views on a number of issues related to loan guarantees. We apologize for the delay in our response.

In your letter, you refer to Interpretation Bulletin IT 239-R2 which states that, if a guarantee has been given for adequate consideration, it will generally have been considered to have been given for the purposes of gaining or producing income. You note that the Bulletin does not state what the character of such income would be. You further comment that, in your view, the Bulletin seems to suggest that where a guarantee of a loan has been given for adequate consideration and the guarantor has been called upon to honour the guarantee so given, the loss that is sustained on the debt is necessarily a capital loss.

In your view, income derived by a guarantor who receives adequate consideration for providing a guarantee should be considered to be business income, either because the guarantor carries on an ongoing business of providing guarantees for a fee, or alternatively because the income is from an adventure or concern in the nature of trade. You wish us to confirm this or, if we disagree, to provide our reasons.

Further, you conclude if the income received by a guarantor is indeed properly regarded as income from a business it would seem to follow that any loss sustained by the guarantor would constitute an expense incurred in the course of the business rather than an expenditure on capital account. You also wish us to confirm this or, if we disagree, to provide our reasons.

Our comments

In our view, the characterization of the income received by a guarantor of a loan for providing a guarantee and the characterization of the loss arising from such guarantee is dependent upon all of the facts of the situation, including the intent of the guarantor in entering into the transaction. We can, however, offer you the following general comments.

1. Characterization of Guarantee Fees

Ordinarily, amounts received as guarantee fees are taxable on income account. For example in The Queen v. R. Audet, 78 DTC 6554, the Federal Court Trial Division found that the amount received by the taxpayer for personally guaranteeing a loan was paid to him for rendering a service and the income was income from a business as an "undertaking of any kind". In Steer v. M.N.R. 65 DTC 5115 (Exchq.) at 5117, Mr. Justice Noel, in arriving at his conclusion that a loss incurred by a guarantor in honouring his guarantee was on account of income, considered it relevant to examine on what basis the guarantor had included the related guarantee fee in income as follows:

It is clear that this was a business transaction pursuant to which the appellant received a payment for doing certain things. Now, whether such a transaction is a venture in the nature of trade so as to be a "business" within the statutory definition or cannot be so regarded, it is clearly, in my view, a "source" from which income may arise within the meaning of section 3 of the Income Tax Act.

In the first place, in my view, the transaction in question is a venture in the nature of trade and therefore a "business" within the statutory definition.

On appeal the Supreme Court of Canada (66 DTC 5481) determined that the amounts paid to discharge the guarantee were more properly characterized as being on account of capital but did not expressly disagree with Mr. Justice Noel's conclusion regarding characterization of the guarantee fees as business income.

2. Capital Loss

As you have mentioned, IT-239R2 (specifically paragraph 4 thereof) does state that if a guarantee is given for adequate consideration, it will generally be considered to have been given for the purposes of gaining or producing income and therefore any loss that is considered to have been incurred by the guarantor on the deemed disposition of the debt acquired on the honouring of the guarantee will be a deductible capital loss. In other words, the Bulletin is confirming that subparagraph 40(2)(g)(ii) of the Income Tax Act which would otherwise deny a loss from the disposition of the debt, will be inapplicable.

The foregoing comments are not meant to suggest that a capital loss will result in every situation where a guarantor has received adequate consideration for granting a guarantee. Rather the above comments must be examined in the context of the heading, "General Positions" modifying paragraphs 3, 4 and 5 of IT-239R2. As previously mentioned, whether a loss on honouring a guarantee will be on account of capital or income depends on the particular facts of each case.

We do not, however, agree that, if guarantee fees received by the guarantor are considered to be business income, it necessarily follows that any loss incurred by the guarantor on honouring the guarantee is on account of income. In this regard we would again refer you to the Steer case where, as mentioned, the guarantee fees paid to the guarantor were considered to be business income, while the loss incurred on honouring the guarantee was on account of capital.

The foregoing comments are given in accordance with the practice of providing non-binding opinions referred to in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990 and are not binding on Revenue Canada, Taxation.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch