30 September 1996 Internal T.I. 9623867 - ABIL

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:

Payment of $XXXXXXXXXX to a bankruptcy trustee by a shareholder of a bankrupt company. The taxpayer guaranteed debt of the corporation. How should the payment be treated?

Position:

ABIL

Reasons:

Taxpayer personally advised that he had to make good on a guarantee he co-signed along with two other shareholders of the now bankrupt corporation which, based on the information provided during a personal telephone conversation with the writer, was a Canadian-controlled private corporation that was a small business corporation at all times prior to bankruptcy, including at the time it last became a bankrupt.

							September 30, 1996

Outaouais TSO HEADQUARTERS
Client Services Division A.M. Brake
15 Eddy Street 16th Floor (613) 957-8953
Attention: Louis Garneau
962386

XXXXXXXXXX

This is in reply to your memorandum of June 27, 1996, relating to the treatment of a payment of $XXXXXXXXXX made by XXXXXXXXXX in a situation which may best be described as follows:

XXXXXXXXXX

You have asked for our comments with respect to whether the amount in question should be treated as either a:

A)allowable business investment loss (ABIL).

B)capital loss.

C)business expense/loss, or
D)legal expense.

Our comments

There is nothing to indicate that the $XXXXXXXXXX could relate to an expense of earning income from business or property by XXXXXXXXXX on a current basis. Based on the information supplied by XXXXXXXXXX during a telephone conversation (Brake/XXXXXXXXXX), XXXXXXXXXX was a shareholder of Company A and he now has reason to believe that he would have become a shareholder of Company B when the amalgamation or takeover occurred. He recalls signing personal guarantees for Company A and feels now that he must have signed similar guarantees for Company B.

Paragraph 39(1)(c) of the Income Tax Act (the "Act") defines a taxpayer's business investment loss from the disposition of property described in subparagraphs 39(1)(c)(iii) {a share of the capital stock of a small business corporation ("SBC")} or (iv) {a debt owing to the taxpayer by a Canadian-controlled corporation ("CCPC"), that is (A), a SBC, or (B), a bankrupt that was a SBC at the time it last became a bankrupt ("Bankrupt SBC") 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 SBC at the time a winding-up order under that Act was made in respect of the Corporation ("Wound-up SBC"). A debt owed to a corporation by a non-arm's length corporation is excluded from the debts referred to in (iv)}. Another requirement within the definition is that there must be an arm's length disposition or a disposition to which subsection 50(1) applies. Subsection 50(1) of the Act provides a deemed disposition with nil proceeds and an immediate acquisition at nil cost, where there is a debt described in paragraph 50(1)(a) of the Act, or share described in subsection 50(1)(b) of the Act. A debt described in paragraph 50(1)(a) is a debt owing to a taxpayer at the end of a taxation year (other than a debt from the sale of personal-use property) that is established by the taxpayer to have become a bad debt in the year.

With regard to a taxpayer making payments on a guarantee, the debt will have been acquired by the taxpayer only at the time a payment is made and it will be the status of the debtor, on whose behalf the payment was made (ie., CCPC, SBC or Bankrupt SBC), at the time of making each payment, that will determine whether the debt is a debt described in subparagraph 39(1)(c)(iv), to be a debt owing to the taxpayer by a CCPC that is (A), a SBC, (B), a Bankrupt SBC or (C), a Wound-up SBC.

Company B was not a SBC at the time the 1995 payment of $XXXXXXXXXX was made as it became bankrupt and ceased to operate XXXXXXXXXX years earlier. It would be necessary, therefore, that Company B retain its status as a Bankrupt SBC or have attained the status of being a Wound-up SBC at the time the payment was made on the guarantee. Otherwise, the $XXXXXXXXXX payment, at this point in the analysis, would not meet the requirements of being a property described in subparagraph 39(1)(c)(iv) of the Act. In this regard, subsection 39(12) of the Act, if the conditions contained therein are met, may provide relief. Subsection 39(12) would deem a payment made by a taxpayer under a guarantee of the debts of a corporation (Company B) to be a debt owing to the taxpayer by a SBC if,

the payment was made to an arm's length person, and

the corporation (Company B) was a SBC both at the time the corporation's debt in respect of which the payment was made was incurred and at any time in the 12 months before the time any amount first became payable under the guarantee.

The status of Company B at the time the payment was made is not known to us. However, if it was either a Bankrupt SBC or a Wound-up SBC, at the time of payment, the payment would qualify as a business investment loss without having to rely on subsection 39(12). Alternatively, if it was neither a Bankrupt SBC nor a Wound-up SBC at the time the $XXXXXXXXXX payment was made in 1995, it could still qualify as a business investment loss, provided the subsection 39(12) requirements were met, and it would seem that they may have, in that the payment was made to an arm's length person and we have no reason to believe that Company B was not a SBC at the time it incurred the guaranteed debt or that it would have ceased to be a SBC more than 12 months prior to the guarantee becoming payable, even though it was not actually paid until XXXXXXXXXX years later. However, it is a question of fact as to when the guarantee became payable.

In summary, the payment could qualify as a business investment loss as defined in subparagraph 39(1)(c)(iv) as being a payment made to a CCPC that was Bankrupt SBC or a Wound-up SBC or, alternatively, as having been made within the requirements of subsection 39(12) and being deemed to be a debt owing to the taxpayer by a SBC for purposes of clause 39(1)(c)(iv)(A) of the Act.

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