18 June 1993 Income Tax Severed Letter 9309655 - Capital Loss on Indemnity Payment

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.

                                                    5-930965
XXXXXXXXXX                                          G. Martineau
                                                    (613) 957-8953

Attention: XXXXXXXXXX

June 18, 1993

Dear Sirs:

Re: Indemnity payment

This is in reply to your letter of March 25, 1993 concerning the income tax consequences of payment to be made by individuals under an indemnity agreement. Under the indemnity agreement, a bonding company may demand payment from these individuals for any expenses incurred on behalf of the bonded company.

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.

Paragraph 4 of Interpretation Bulletin IT-239R2 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". Upon payment of the debt, the guarantor becomes subrogated to the original creditor. In the process the guarantor steps into the shoes of the original creditor and acquires the same rights and remedies available to the original creditor, e.g., right to repayment, interest and reimbursement of costs, if any. In our view, a payment under an indemnity where the payor is not subrogated to the creditor would not result in the acquisition of a debt for the payor and in a capital loss.

However, if a debt is acquired by the payor by reason of the subrogation and this debt is subsequently determined to be a bad debt, subsection 50(1) of the Income Tax Act (the "Act") deems the debt to have been disposed of for nil proceeds, resulting in a capital loss. However, subparagraph 40(2)(g)(ii) of the Act deems the payor's capital loss for tax purposes to be nil where the indemnity was given for no consideration.

The Department's administrative position with respect to the deductibility of capital losses arising from guaranteeing loans by a shareholder for inadequate consideration is set out in IT-239R2 . It is the Department's practice to allow a loss on such a guarantee and not to treat it as being nil by virtue of subparagraph 40(2)(g)(ii) of the Act if certain conditions as described in paragraph 6 of IT-239R2 are satisfied. The Department would apply, by analogy, the treatment outlined in the IT-239R2 to situations where a payment is made by a shareholder under an indemnity agreement and there is subrogation, if the conditions in paragraph 6 of the said Bulletin were met.

We trust our comments will be of assistance to you.

Yours truly,

for Director Financial Industries Division Rulings Directorate Legislative and Intergovernmental Affairs Branch