5 February 1993 Income Tax Severed Letter 9229785 - Indemnity Payment—Capital Disposition—Guarantee

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.

922978
XXXXXXXXXX Glen Thornley
(613) 957-2101

Attention: XXXXXXXXXX

February 5, 1993

Dear Sirs:

Re: Indemnity Payment

This is in reply to your letters of September 23, 1992 and January 5, 1993 concerning the income tax consequences of a payment made from one individual to another in order that the payer would be absolved from meeting possible future payments under a guarantee.

As we understand it, equal shareholders of a corporation in a loss position in the first two years of its operation have had a falling-out. The company debts are guaranteed equally by each shareholder. Shareholder B agrees to buy all shareholder C's shares for $1.00, however C agrees to pay $25,000 to B in order to be absolved of his contingent liability under a guarantee for their company's debts.

You ask if the payment by C to B would qualify as a capital loss when paid or whether the loss is denied by subsection 40(2) of the Income Tax Act (the "Act"). If it is a capital loss, you ask if it would qualify as an allowable business investment loss pursuant to paragraph 39(1)(c) of the Act. You then ask if, from B's perspective, the payment is taxable when received.

It appears that the interpretation you seek relates to a proposed transaction to be undertaken by a specific taxpayer and, therefore, we bring to your attention Information Circular 70-6R2 dated September 28, 1990 issued by Revenue Canada, Taxation. Confirmation with respect to proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. If you wish to obtain an advance income tax ruling for a particular taxpayer with respect to specific transactions which are contemplated, a written request for an advance income tax ruling can be submitted in accordance with the Information Circular. Nevertheless, we can offer the following general comments.

Our Comments

The Department's administrative position with respect to the deductibility of capital losses arising from guaranteeing loans by a shareholder is set out in Interpretation Bulletin IT-239R2. Paragraph 4 of that bulletin states "A taxpayer who is required to honour a guarantee is considered to have acquired a debt at the time that the guarantee is honoured equal to the amount of payment(s) made pursuant to the guarantee". The Department is not prepared to extend the treatment outlined in IT-239R2 to situations where a voluntary payment is made by one shareholder to another shareholder in order to obtain indemnification from having to honour, at some future time, a guarantee given to a creditor of the corporation of which the individual is a shareholder.

In order for there to be a capital loss there must be a disposition giving rise to the capital loss. A payment made gratuitously in order to be absolved from a contingent liability would not appear to be a disposition of a capital property, however, even if found to be a capital payment it would not be considered to be "made or incurred...for the purpose of gaining or producing income...". Thus, paragraph 40(2)(g) would deny a deduction for the payment.

Generally, it is our view that a payment received by an individual to indemnify another individual from possible liability under a guaranty would be on account of income and therefore taxable in the recipients hands when received or when receivable.

We trust our comments will be of assistance to you.

Yours truly,

Roberta Albert
for Director
Business and General Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch