4 May 1993 External T.I. 9236325 F - Bad Debt and Capital Loss

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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Dear Madam:

RE:  Subsection 50(1) of the Income Tax Act (the "Act")

We are writing in response to your letter of November 24, 1992 wherein you requested our confirmation that the winding-up and the consequential elimination of the intercompany loan in the situation described in your letter will not affect the deductibility of an allowable capital loss that arose as a result of the application of subsection 50(1) and paragraph 39(1)(b) of the Act to the intercompany loan. We apologize for the delay in responding.

The situation described in your letter involves a Canadian-controlled private corporation ("Parentco") which previously claimed a capital loss in respect of a loan (the "Loan") made to its insolvent U.S. wholly-owned subsidiary ("Subco") which has ceased to carry on its business. The Loan bore interest at commercial rates. Parentco wishes to wind up Subco. No assets will be distributed to Parentco on the winding-up of Subco as Subco is insolvent. The Loan will be eliminated on the winding-up of Subco into Parentco.

The situation outlined in your letter appears to involve actual proposed transactions and identifiable taxpayers. Confirmation as to the income tax consequences of proposed transactions will only be given in the context of an advance income tax ruling. However, in accordance with the guidelines described in paragraph 6 of Information Circular 70-6R2, it is not the Department's practice to issue rulings concerning the tax consequences of any proposed transactions on other transactions that are already completed or on series of transactions that are significantly advanced. Accordingly, the appropriate district taxation office should be consulted on the effect of the winding-up of Subco, if any, on the capital loss sustained by Parentco in prior years. Notwithstanding the above, we can offer the following general comments. For the purposes of these comments, we have assumed that the receivable is a capital property of the taxpayer.

Under subparagraph 40(2)(g)(ii) of the Act, a taxpayer's capital loss on the disposition of a debt or other right to receive an amount is nil unless

(a)     the debt or right was acquired by the taxpayer for the purpose of gaining or producing income (other than exempt income) from a business or property, or

(b)     the debt or right was acquired by the taxpayer as consideration for the disposition of capital property to a person with whom the taxpayer was dealing at arm's length.

Where a debt or right to receive an amount was acquired by a creditor for the purpose of gaining or producing income from a business or property and the debt became bad (when and whether a debt has become bad is a question of fact which is dependent upon the circumstances in each case) in a particular year, the provisions of subsection 50(1) of the Act would apply to deem the creditor to have disposed of the debt at the end of that year for proceeds equal to nil and to have reacquired it immediately thereafter at a cost equal to nil. Consequently, a capital loss as determined under paragraph 39(1)(b) of the Act, or in some circumstances, a business investment loss as determined under paragraph 39(1)(c) of the Act would result. Any future recovery of the debt by the creditor will be treated for tax purposes as a capital gain since the adjusted cost base of the debt to the creditor is nil. Provided that the creditor receives no further payments in respect of the debt after the application of subsection 50(1) of the Act, no further tax consequences should arise to the creditor. However, in the case of a debtor which is taxable in Canada, either subsections 80(1) or (3) of the Act may be applicable to the debtor at the time the debt is settled or extinguished.

We trust that our comments will be of assistance.

Yours truly,

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch