26 June 1992 Income Tax Severed Letter 9217105 - Small Business Development Bonds

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

SUBJECT: SMALL BUSINESS DEVELOPMENT BONDS SECTION: 15.1]

921710
Allan Nelson
(613) 957-2745

Attention: 19(1)
June 26, 1992

Dear Sirs:

Re: Small Business Development Bonds ("SBDB's")

We are writing in response to your letter to us dated June 1, 1992, concerning the proposed SBDB legislation, which was announced by the Minister of Finance on February 25, 1992.

It is our understanding the detailed rules for the proposed SBDB's will be very similar to those now described in section 15.1 of the Income Tax Act (the "Act"). Therefore, our response to your queries will quote references in the Act as it presently reads, keeping in mind that if and when the proposed legislation is enacted, these references may be changed. We also note that you are familiar with and have a copy of Interpretation Bulletin IT-507. That Bulletin will be used as the basis for administering the new program.

The situation outlined in your letter relates to specific proposed transactions. It is the practice of this Department not to comment on such transactions when the identities of the taxpayers and all of the relevant facts are not known. However, we can provide you with the following general comments which we hope will be of assistance to you.

Provided the Act is amended such that the new legislation for SBDB's is substantially the same as presently described in section 15.1 of the Act, our views are as follows:

• 1. Pursuant to subsection 15.1(1) of the Act, a corporate recipient of an interest payment made on a SBDB will be deemed to have received a taxable dividend. Assuming the issuer of the SBDB is a taxable Canadian corporation, subsection 112(1) of the Act would permit the corporate recipient to deduct an amount equal to the deemed dividend, in the computation of its taxable income for the year.
• The provisions of subsections 112(2.1) to (2.4) would not apply to deny this subsection 112(1) deduction.
• 2. It is a question of fact whether or not a taxpayer is eligible to issue a SBDB due to financial difficulty.
• As you noted, paragraphs 10 and 11 of IT-507 indicate the Department will, within defined parameters, rely upon the reasonable judgement of lenders in determining if the debt is in default and if the default is due to financial difficulty.
• Subsection 15.2(5) of the Act provides a penalty for a borrower which knowingly or under circumstances amounting to gross negligence makes a false declaration in the SBDB joint election. Although a borrower may be subject to such a penalty, the debt continues to qualify as a SBDB, for both the borrower and the lender. No penalty is levied against the lender which has exercised reasonable judgement in fulfilling its obligations in respect of the SBDB.
• 3. Rejected mortgage applications from other unrelated financial institutions, which normally make loans of the type required by the borrower, would be acceptable evidence indicating that further financing was not available to the borrower, except through the issuance of an SBDB.
• 4. The beneficial shareholders and any associated corporations must state in writing that they are not able to provide further financing to the borrower. We have no set guidelines concerning what additional information is required to support these written statements, as this would depend on the facts in each case. In some financial difficulty situations, we have seen net worth or cash flow statements included to support the shareholders' representations.
• 5. Subparagraph 11.(a) of IT-507, lists as one of the conditions to be satisfied before a valid SBDB can be issued that
• the issuer is in default or is expected to default on a debt held by a person with whom it deals at arm's length (i.e., it cannot reasonably be expected to make payments on its obligations as they become due) and it cannot reasonably be expected to obtain sufficient financing to avoid such a default except through the issuance of an SBDB;
• This condition would not be satisfied merely because the borrower is currently in default of the debt. Other factors must be considered such as the nature of the default. Is it a technical default or a temporary default which is expected to be corrected in the near future (these types of defaults would not meet the requirement)? Is the default due to financial difficulty which is expected to be an ongoing problem, subject to the issuance of a SBDB (these types of defaults would meet the requirement)?
• 6. It is at the time of issuance of the SBDB that the borrower must meet the financial difficulty test. Therefore, the tax treatment of a SBDB remains unchanged when the financial position of the borrower improves before the expiry of the term of the SBDB.

The opinions expressed in this letter do not constitute an advance income tax ruling and, as stated in paragraph 21 of Information Circular 70-6R2, are not binding on the Department.

Yours truly,

Chief
Leasing & Financing
Financial Industries Division
Rulings Directorate