7 April 1994 External T.I. 9400125 - ABIL ON SHAREHOLDER'S LOAN

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.

Principal Issues:

Is a loss on a shareholder's loan an allowable business investment loss?

Position TAKEN:

Depends on the facts of the case, it could be.

Reasons FOR POSITION TAKEN:

5-931790

			5-940012

XXXXXXXXXX L. Roy

Attention: XXXXXXXXXX

April 7, 1994

Dear Sirs:

Subject: Allowable business investment loss on shareholder's loan

This is in reply to your letter of December 24, 1994 in which you requested our comments regarding the above-mentioned matter. We apologize for the delay in replying to your letter.

All references to statute are to the Income Tax Act S.C. 1970-71-72, c.63, as amended consolidated to June 10, 1993 (the "Act").

The situation described in your letter appears to involve actual completed transactions with identifiable taxpayers. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R2, dated September 28, 1990. Where the particular transactions are completed, as in your case, the enquiry should be addressed to the relevant district taxation office. The following comments are, therefore, of a general nature only, and are not binding on the Department. These comments should not be considered as confirming that the loss in your situation is an allowable business investment loss. Furthermore, our comments set out below are based on the assumption that the shareholder's loan bear interest at less than a reasonable rate.

A taxpayer's business investment loss ("BIL") is defined in paragraph 39(1)(c) of the Act. To qualify as BIL, an amount must first qualify as a capital loss. Thus where a transaction does not give rise to a capital loss, or where a capital loss is deemed to be nil under paragraph 40(2)(g) of the Act, no BIL can result.

Subsection 50(1) of the Act deems a debt which has become a bad debt in a taxation year to have been disposed of at the end of that year. 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 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.

A loss resulting from that deemed disposition will be nil according to subparagraph 40(2)(g)(ii) of the Act unless the debt was acquired for the purpose of gaining or producing income from a business or property. However, paragraph 6 of Interpretation Bulletin 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 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 which 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 made every effort to borrow the necessary funds through the usual commercial money markets but could not 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.

Provided that the taxpayer's capital loss is not deemed to be nil by virtue of subparagraph 40(2)(g)(ii) of the Act, the taxpayer may have a BIL 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 of a debt (to which subsection 50(1) of the Act applies) 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.

the loss will qualify as a business investment loss within the meaning of paragraph 39(1)(c) of the Act.

For business investment loss purposes, a "small business corporation" includes a corporation that was a "small business corporation" as defined in subsection 248(1) of the Act at any time during the 12 months preceding the disposition.

We trust the above comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Rulings Directorate