8 February 1996 Internal T.I. 9529667 - ABIL - SHAREHOLDER 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:

Whether an allowable business investment loss can be claimed in respect of money loaned by taxpayers to a corporation which has ceased to carry on business.

Position:

Cannot determine.

Reasons:

Lack of information.

								February 8, 1996

	XXXXXXXXXX Tax Services Office	HEADQUARTERS
	Client Assistance				C. Chouinard
								957-8953
Attention: XXXXXXXXXX
								7-952966

Loss in Respect of Shareholder Loans

This is in response to your memorandum of November 3, 1995 to which you attached a letter forwarded to you by a taxpayer requesting a ruling. As indicated during a telephone conversation (Chouinard/XXXXXXXXXX), since the letter does not evidence a proposed transaction, we cannot provide the taxpayer with a ruling. However, as agreed, we are providing you with our comments regarding the situation described by the taxpayer.

Facts

We understand the facts to be as follows:

In April 1991, a corporation was formed to operate a XXXXXXXXXX franchise. The taxpayer and his spouse (the "taxpayers") borrowed $XXXXXXXXXX from a financial institution and lent this money, along with $XXXXXXXXXX, to the corporation. During the period from May 27, 1991 to August 26, 1992, the corporation paid to the taxpayers a monthly payment in respect of the loan. The excess of the interest earned over the interest paid on the loan was reported by the taxpayers as interest income in their income tax returns. On or about August 27, 1992, the corporation ceased to carry on business. At that time, the outstanding amount owing to the taxpayers was $XXXXXXXXXX. Although the corporation has not been dissolved, it has not done business since August 27, 1992 and has no assets. The taxpayers attempted to deduct the amount of the loan outstanding as an allowable business investment loss and were denied the deduction on the basis that the loan was not an arm's length transaction.

Our Comments

Given the limited information provided and because certain questions of fact need to be resolved, we cannot determine conclusively whether the loss in respect of the money loaned to the corporation by the taxpayers can be claimed as an allowable business investment loss. Accordingly, we are providing you with general comments which may be of assistance in resolving this matter. You should note, however, that, in our view, the fact that the loan was made by the taxpayers to a non-arm's length person is not determinative of the issue and there is nothing obvious in the brief facts as presented which would preclude this loss from qualifying as an allowable business investment loss.

According to paragraph 2 of Interpretation Bulletin IT-159R3, under paragraph 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 was acquired by the taxpayer for the purpose of gaining or producing income from a business or property. As indicated in paragraph 5 of Interpretation Bulletin IT-239R2, money which has been loaned at a reasonable rate of interest generally constitutes a debt acquired for the purpose of gaining or producing income, and any capital loss which arises because it has become uncollectible is generally not deemed to be nil by virtue of subparagraph 40(2)(g)(ii) of the Act. It is the Department's view that money has not been loaned at a reasonable rate of interest where a taxpayer borrows money at interest and loans that money to a corporation of which he or she is a shareholder at a lesser rate of interest than that at which the taxpayer borrows the money. However, in such circumstances, the loss arising to the taxpayer from the corporation's inability to discharge its obligations to him or her may be a deductible capital loss if the conditions set out in paragraph 6 of IT-239R2 are satisfied.

A capital loss arising from the disposition of a debt that has become a bad debt may qualify as a business investment loss within the meaning of paragraph 39(1)(c) of the Act if the debt that generated the loss was owed to the taxpayer by a small business corporation and if the disposition of the debt was either to a person with whom the taxpayer was dealing at arm's length or one to which subsection 50(1) of the Act applies. 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 the year. Whether a corporation is a small business corporation and the time at which a debt becomes a bad debt are questions of fact. Paragraph 10 of IT-159R3 states that, generally, a debt will be uncollectible at the end of a particular taxation year if the creditor has exhausted all legal means of collecting it or the debtor has become insolvent and has no means of paying it.

R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch