1993 Internal T.I. 9324587 F - Rights or Things; Bad Debts

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.

February 8, 1994

Attention:  Albert Iacovon

XXXXXXXXXX

This is in response to your memo dated August 24, 1993 wherein you requested our opinion regarding the deductibility in the year of death of amounts owing by a cash farmer at the time of his death to a corporation owned by his parents to reimburse the corporation in respect of farm supplies purchased by the corporation for use in his farm business. You state the purchases were made by the corporation because the combined purchasing power of the corporation and the deceased resulted in lower costs to the deceased. You further state that the taxpayer intended to repay the amounts by the end of his 1990 taxation year but that his death prevented him from doing so.

Our opinion

The general provision setting out the deductions available to cash farmers is paragraph 28(1)(e) of the Act, which provides that only amounts which have been paid are deductible, subject to some other provision which might deem the amount to have been paid in the year.

Having historically elected to report his income on a cash basis, and not having changed methods in the manner provided for in subsection 28(3), the taxpayer is obliged to file on a cash basis in the year of death subject only to specific rules providing otherwise, such as subsection 70(2) in respect of rights or things or subsection 70(1) in respect of amounts receivable on a periodic basis.

Subsection 70(2) is discussed in IT-212R3. Paragraphs 8 and 9 thereof consider the livestock and grain inventory of a cash farmer to be rights or things. Paragraph 4 thereof provides that a taxpayer may deduct from the gross amount of a right or thing amounts incurred but unpaid which, had the taxpayer not died, would have been deductible in computing the taxpayer's income. Paragraph 5 thereof provides that in circumstances where the deductions in respect of rights or things exceed the gross amount of the rights or things, the taxpayer may deduct this amount from other income on the final return of the deceased taxpayer. Notwithstanding that the taxpayer had sold all of his livestock and grain inventory and therefore one might argue that, from a technical standpoint, the provisions in Interpretation Bulletin IT-212R3 are of no application, we are of the view that the taxpayer falls within the scope of the inequities which paragraphs 4 and 5 of that Bulletin were attempting to address, namely the situation where a taxpayer is required to include in income cash receipts without their being offset or matched by related expenses which almost certainly would have been paid in the year but which, owing to the taxpayer's death, were not in fact paid.

With respect to whether the corporation owned by the deceased taxpayer's parents is entitled to a deduction in respect of a bad debt, we are of the view that how they choose to treat the amount is of no consequence to the deceased taxpayer. With respect to the corporation owned by the deceased's parents we are not sufficiently aware of the facts surrounding the outstanding advance of $ XXXXXXXXXX and the estate's failure to repay the amount to the corporation to forcefully offer an opinion. We offer, however, the following general comments:

Interpretation Bulletin IT-442R describes the Department's policy in regards to the deductibility of bad debts under subparagraph 20(1)(p)(i) or uncollectible loans under subparagraph 20(1)(p)(ii) of the Act.

Paragraph 1 thereof provides that in order for an amount to be deductible as a bad debt, the amount must have been a debt owing to the taxpayer at the end of the year, it must have become bad during the year, and it must have been included or be deemed to be included in the taxpayer's income for the year or a previous year. While the first test would appear to have been met, the corporation would have to be able to show in the year of deduction that the debt was in fact bad.

While there are no precise rules regarding when such a situation exists, Paragraph 6 of the IT Bulletin provides that it can only be after a "determined efforts to collect the debt have been unsuccessful or there is clear evidence to indicate that it has in fact become uncollectible". With respect to the third test, however, we doubt, given the circumstances under which the purchases were made on behalf of the son, that the corporation would have included any amount in respect of the purchases in income. If that is the case, then no deduction would be available under subparagraph 20(1)(p)(i) of the Act.

Whether the amount would be deductible under subparagraph 20(1)(p)(ii) of the Act would require, in addition to whether the amount is uncollectible, an analysis of whether the lending of money is part of the corporation's ordinary course of business. Factors to consider are whether interest was being charged and whether the loans were being made on a systematic and continuing basis.

Assuming the corporation is unable to deduct the amount as a bad debt or uncollectible loan, the taxpayer might nevertheless be entitled to deduct the amounts in issue (again assuming their uncollectibility) if they were laid out for the purpose of gaining or producing income from a business. It is a question of fact whether the reduction in the corporation's costs arising from increased purchasing power achieved from the arrangements with the shareholder's son justify the outlay.

One would want to consider, among other things, the extent of the savings to the corporation, the risk of the advance not being repaid, the security taken by the corporation - if any, how the corporation financed the purchases and how those costs compared with the anticipated savings, when the son generally repaid the amounts, the son's financial circumstances and whether he would have been able to finance the purchases independently, and whether the corporation would likely have entered into similar transactions with arm's length parties. In essence, the question to be answered is whether family considerations drove how the corporation acted rather than commercial considerations.

We trust these comments will be of assistance.

Murray Brake for DirectorBusiness and General DivisionRulings and Intergovernmental Affairs Branch