25 January 1996 Internal T.I. 9529806 - CAP LOSS ON FORGIVENESS ON NON-INTEREST DEEMED NIL

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:

validity of the position in para 6 & 10 of IT239R2 & contrast with IT-159

Position:

Position is valid and loss is correctly deemed to be nil. The position in IT-159 would allow the taxpayer to not recognize the loss so that any future recovery would not create a gain -in this case, it is academic since the taxpayer has forgiven a portion of the loan

Reasons:

the position in the bulletin which allows the recognition of the capital loss is administrative because the Dept does not recognize the indirect use/intent argument. In the case of an interest deduction, the indirect use or preservation of capital is not a tenable argument for allowing the interest deduction which would otherwise be denied without 20(1)(c). In the case of funds loaned to another party, the same argument holds -that is that a hope of earning income from some other source (i.e the shares) is too remote a connection to the non-interest bearing debt to say that the loan was incurred for the purpose of earning income from a business or property

		January 25, 1996

Appeals and Referrals Division HEADQUARTERS
Lorraine Tremblay A. Humenuk
Director 957-8953
Attention: Ken Berini
952980

Application of Paragraph 40(2)(g)(ii) to a Non-interest Bearing Debt

We are replying to your memorandum of November 6, 1995 concerning the position set out in Interpretation Bulletin IT-239R2 concerning the application of subparagraph 40(2)(g)(ii) of the Act to a debt which bears less than a reasonable rate of interest.

XXXXXXXXXX

Insofar as the debt did not bear a reasonable rate of interest and the criteria set out in paragraphs 6 and 10 of Interpretation Bulletin IT-239R2 did not apply in respect of the debt forgiven by XXXXXXXXXX return was reassessed to delete the ABIL claimed. XXXXXXXXXX has objected to the reassessment, stating that the debt was disposed of to an arm's length party. Notwithstanding that XXXXXXXXXX claim that the debt was disposed of to an arm's length party appears to contradict the statement of facts as presented in your memorandum, namely the fact that the debt was forgiven, you have asked whether the position in IT-239R2 is still valid given the recent court decisions, such as National Developments Ltd. v The Queen (94 DTC 1061), Business Art Inc. v The Queen (86 DTC 1842), Floyd R. Glass v The Queen (92 DTC 1759) which appear to have cast doubt on the validity of this position.

As stated at the 1995 Tax Executive Institute and other conferences, the Department's position regarding the deductibility of capital losses resulting from indebtedness bearing less than a reasonable rate of interest remains as stated in IT-239R2.

XXXXXXXXXX

XXXXXXXXXX

If there were no terms of repayment in place for the debt which was ultimately forgiven by XXXXXXXXXX, it is doubtful that the taxpayer could establish that the debt was in fact a bad debt in the year as is required in order for paragraph 50(1)(a) of the Income Tax Act to apply. As stated in paragraph 10 of IT-159R3, a debt or portion thereof will not be considered to be bad unless the whole amount of the debt is uncollectible.

You also ask for our comments on the difference between the administrative practice described in paragraph 2 of IT-159R3 and that of paragraph 6 of IT-239R2. Paragraph 2 of IT-159R3 does not set out a position under which a capital loss will be allowed but rather discusses the tax treatment to be applied where the capital loss which might otherwise have been claimed in respect of a bad debt had been deemed to be nil by reason of subparagraph 40(2)(g)(ii) of the Act. If a debt which has been established to be bad in the year has not been acquired for the purpose of gaining or producing income (under the criteria as discussed above) and the criteria set out in paragraph 6 and 10 of IT-239R2 are not met for that year, the Department takes the position that the deeming provisions of subsection 50(1) as it applied to taxation years ending before February 21, 1994 do not apply. The intent of the position set out in paragraph 2 of IT-159R3 is to eliminate the potential capital gain which might otherwise arise upon the collection of a debt which had previously been established to be bad where the capital loss arising from that previous deemed disposition was deemed to be nil by reason of subparagraph 40(2)(g)(ii) of the Act.

For taxation years ending after February 21, 1994, the position in the bulletin will have little relevance since it is unlikely that a taxpayer would elect to have section 50 apply so that a loss which is deemed to be nil by reason of subparagraph 40(2)(g)(ii) of the Act might be recognized. Nevertheless, where the taxpayer, unaware that the loss was deemed to be nil by reason of subparagraph 40(2)(g)(ii) of the Act, has elected to realize a loss which is deemed to be nil by reason of that subparagraph, the Department will permit a taxpayer to rescind such an election.

Roy C. Shultis
Interim Director General
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
Enclosure