23 December 1993 Income Tax Severed Letter 9317905 - Allowable Business Investment 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.

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.

                                          931790
XXXXXXXXXX

Attention: XXXXXXXXXX

December 23, 1993

Dear Sirs:

Re: Allowable Business Investment Loss Treatment on Non-Interest Bearing Advances by a Shareholder to a Corporation

This is in reply to your letter of June 8, 1993. We apologize for the delay in responding.

You have asked whether a capital loss and an allowable business investment loss would be granted in the following situations:

(1) Where a non-interest bearing loan, together with the shares of a small business corporation, was sold by a shareholder at a loss to an arm's length party.

(2) Where a non-interest bearing loan was sold by a shareholder at a loss to an arm's length party without the shares being sold.

(3) Where there is no sale of the loan but the shareholder feels the loan is uncollectible despite the fact that the business continues. The loan could be triggered pursuant to paragraph 50(1)(a). For this purpose would the loan have to be formally written off?

Our Comments

The situations described in your letter appear to involve actual proposed transactions with identifiable taxpayers. Assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R2 dated September 28, 1990, and the Special Release thereto dated September 30, 1992, issued by Revenue Canada, Taxation. However, we can offer the following general comments.

The Department's position concerning the deductibility of losses from loaning funds at less than a reasonable rate of interest is outlined in Interpretation Bulletin IT-239R2 .

As stated in paragraph 3 of IT-239R2 pursuant to subparagraph 40(2)(g)(ii) of the Income Tax Act (the "Act"), a taxpayer's loss arising from the disposition of a debt is nil unless the debt had been acquired for the purpose of gaining or producing income from a business or property. Subsection 50(1) deems a debt which has become a bad debt in a taxation year to have been disposed of at the end of that year. A loss resulting from that deemed disposition may therefore be deemed to be nil by the provisions of subparagraph 40(2)(g)(ii) of the Act.

Paragraph 6 of IT-239R2 provides, inter alia, that where a taxpayer has loaned money at less than a reasonable rate of interest to a Canadian corporation of which he is a shareholder, any subsequent loss arising to him from the inability of the corporation to discharge its obligations to him may be a deductible capital loss to him despite the absence of a reasonable rate of interest. Generally it is the Department's practice to allow a loss on such a loan and not treat it as being nil by virtue of subparagraph 40(2)(g)(ii) of the Act if the following conditions are satisfied:

     (a)  the corporation to whom the loan was made used the
          borrowed funds in order to produce income from
          business or property, or used the borrowed funds
          to lend money at less than a reasonable rate of
          interest to its Canadian Subsidiary in turn to be
          used to produce income from business or property,

     (b)  the corporation has made every effort to borrow
          the necessary funds through the usual commercial
          money markets but cannot obtain financing without
          the guarantee of the shareholder at interest rates
          at which the shareholder could borrow.

     (c)  the corporation has ceased permanently to carry on
          its business, and

     (d)  the loan from the shareholder to the corporation
          at less than a reasonable rate of interest (or at
          no interest) does not result in any undue tax
          advantage to either the shareholder or the corporation.

In a situation in which the requirement in (c) above is not met, such as in the case when a shareholder sells his shares of the Canadian corporation to persons who intend to continue operating the corporation, and, as a result, also transfers to the purchasers, or settles, his loan at less than face value, the amount by which the adjusted cost base of the shareholder's debt exceeds the proceeds therefor will be a deductible capital loss if the following conditions as outlined in paragraph 10 of IT-239R2 are met:

(a) the sale of shares is at arm's length,

     (b)  the agreement of the shareholder to accept an
          amount less than the amount of the debt owing to
          him must be a condition of the sale of shares (or
          antecedent thereto), and

     (c)  the conditions specified in paragraphs 6(a), (b)
          and (d) of 
IT-239R2
, as described above, are also
          applicable to the loan. 

Provided that the taxpayer's loss is not deemed to be nil by virtue of subparagraph 40(2)(g)(ii) thereby creating a capital loss under paragraph 39(1)(b) of the Act, the taxpayer may have a business investment loss as defined in paragraph 39(1)(c) of the Act.

If the taxpayer's capital loss for the year is from the disposition after 1977

(i) to which subsection 50(1) applies, or

(ii) to a person with whom he was dealing at arm's length

of any property that is

     (iii) a share of the capital stock of a small business
           corporation, or

      (iv) a debt owing to the taxpayer by a Canadian-controlled
           private corporation (other than, where the taxpayer is
           a corporation, a debt owed to it by a corporation with
           which it does not deal at arm's length) that is

(A) a small business corporation,

      (B)  a bankrupt (within the meaning assigned by
           subsection 128(3)) that was a small business
           corporation at the time it last became a bankrupt,
           or

      (C)  a corporation referred to in section 6 of the
           Winding-up Act that was insolvent (within the
           meaning of that Act) and was a small business
           corporation at the time a winding-up order under
           that Act was made in respect of the corporation.

he would have a business investment loss as determined under paragraph 39(1)(c) of the Act.

The term "small business corporation" has the meaning assigned by subsection 248(1) of the Act.

Whether a debt is a "bad debt", subject to the provisions of subsection 50(1) of the Act, is a question of fact which can only be determined upon an examination of all relevant facts in the situation. In this regard, paragraph 6 of Interpretation Bulletin IT-442R states in part that there are no specific conditions that must be met before a debt may be classed as a "bad debt". Such a decision should be made only after determined efforts to collect the debt have been unsuccessful or there is clear evidence to indicate that it has in fact become uncollectible. If a debt is merely doubtful of collection, it should not be claimed as a bad debt but should be considered for purposes of a reserve for doubtful debts.

In conclusion, depending on all of the facts of each particular situation, it would appear that situation (1) and (3) described above may qualify as business investment losses. However, situation (2) would not.

We trust that these comments will be of assistance.

Yours truly,

A.M. Brake for Director Business and General Division Rulings Directorate Legislative and Intergovernmental Affairs Branch