17 November 1997 Internal T.I. 9726496 - ABILS-DATE OF DISPOSITION

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:

in which year(s) an ABIL is available to shareholder. Corporation is a SBC and CCPC. In Nov 95, the corp. ceases all business operations and sells all assets except land and building. The building is listed for sale and rented from Nov 95 until sale date in September 96.

Position:

Number of assumptions made to work with example given. Scenario One: If rental income is income from an active business, and the full amount of the debt is bad as of December 31, 95 then (i) the corp is an SBC throughout the period until the land and building are sold, (ii) an ABIL on debt is deductible in 95 and (iii) no ABIL may be deducted on the shares until 96. If instead the debt is established by the taxpayer to only have become bad in 96, the ABIL on the debt would be available in 96. Scenario Two: If the rental income is not income from an active business, and the full amount of the debt is established to have become bad in 95 then (i) the corporation ceases to be an SBC in November 95, (ii) an ABIL on the debt is deductible in 95 and (iii) no ABIL on the share will be available in 95 (requirement in 50(1)(b)(iii)(B) not met) or 96 (not an SBC). If the debt was established by the taxpayer to have become bad in 96, no ABIL on the debt in 95 or 96.

Reasons: E58895, E9114535, E9502255, E9500567, E9337751

				November 17, 1997

	Verification Division	HEADQUARTERS
	Verification, Enforcement	Sandra Short
	  Compliance Research Branch			(613) 957-2136

	Attention:  Mark Richer
		972649

Allowable Business Investment Losses: Date of Disposition

This is in reply to your memorandum of September 30, 1997 concerning the calculation of an allowable business investment loss ("ABIL"). You have asked that we consider the following example:

A corporation is a small business corporation (SBC) and Canadian-controlled private corporation (CCPC). In November, 1995, the corporation ceases ordinary business operations and sells all assets except land and building. The building is listed for sale and rented from November, 1995 until the date of sale in September, 1996.

Because the application of the Income Tax Act (the "Act") differs for losses arising in respect of shares as compared to debts, we will expand this example with the following assumptions of fact:

1.The controlling shareholder "X" is an individual who holds both shares and debt at all relevant times.

2.By the time that the land and building are sold in September 1996, it is clear that the corporation will default on at least some of its debts.

3.The shareholder debt was acquired for the purpose of gaining or producing income from a property (such that the application of subparagraph 40(2)(g)(ii) of the Act is not an issue).

4.At no relevant time has a winding-up order been issued under the Winding-Up Act, nor has the corporation been declared a bankrupt (such that the application of clauses 39(1)(c)(iv)(B) and (C) and subparagraphs 50(1)(b)(i) and (ii) are not at issue).

5.X has elected in her 1995 return to have subsection 50(1) apply in respect of both the shares and debt.

Given these facts, we will consider separately the circumstances under which the taxpayer may have a business investment loss in respect of the shares or debt.

Shareholder Debt:

A business investment loss on a debt that has been disposed of is provided for in subparagraph 39(1)(c)(iv) of the Act if one of the conditions in clauses (A) to (C) is present. We have assumed above that clauses (B) and (C) do not apply, therefore, it is necessary that the corporation be an SBC at the time of disposition. The definition of an SBC in subsection 248(1) provides that an SBC includes:

"for the purposes of paragraph 39(1)(c), a corporation that was at any time in the 12 months preceding that time a small business corporation."

That is to say, as long as the debt is disposed of within 12 months of the date that the corporation ceased to be an SBC (if indeed it did so cease to be: this is a question of fact which is discussed in more detail below), X's loss on the debt will be a business investment loss.

The date of disposition in this case is not the actual date of disposition (which you may note that we have not identified in our assumptions), as long as the taxpayer has made a valid election pursuant to paragraph 50(1)(a). In this regard, it is the creditor, X, who establishes the date on which the debt has become a bad debt, not the Minister. (To accept the evidence of an individual asserting the existence of a bad debt, the Court must be convinced from that evidence that the taxpayer in question has acted honestly and on sound general principles: see Geoffrey Hogan v. The Minister of National Revenue, 56 DTC 183, and Leonidas Roy v. The Minister of National Revenue, 58 DTC 676.) The deemed disposition occurs at the end of the year, December 31, 1995, in our example. It is, however, the Department's view that the shareholder must have adequate knowledge that the debt is bad in order to make that determination. Whether this is so will depend on the circumstances of the particular case. In our example, the fact that the corporation ceased to carry on its normal operations in November of 1995 may indicate that a certainty of default could have been established at that time.

It is also our position that the debt is not bad until it may be determined that the whole amount is uncollectible, or a portion settled and the remainder uncollectible as explained in paragraph 10 of Interpretation Bulletin IT-159R3. Whether X could have expected a portion of the debt to be repaid out of the proceeds of the sale of the land and building would need to be considered.

The material and relevant facts available to X may require or permit X to conclude that the debt is bad in 1996. In this case, if the election is made in 1996, the disposition will be deemed to have taken place as at December 31, 1996. Whether this is within the 12-month period now depends on the time at which the corporation is considered to have otherwise ceased to be a SBC.

Small Business Corporation - Active business

The first requirement in the definition of an SBC in subsection 248(1) of the Act is that substantially all of the value of the assets be used principally in an active business. "Active business" is defined in subsection 248 as any business other than a specified investment business, which in turn is defined in subsection 125(7) as a business which has as its principal purpose the earning of income from property.

At first glance the corporation appears to be earning income principally from property after November 1995. However, if the rental income and the delay in holding the land and building until sold may be considered to be only incidental to the normal business operations of the corporation, the corporation may be considered not to have ceased active business simply because it ceased its normal operations. The purpose of holding the land and building may not be to earn property income but for the principal purpose of reducing losses until a buyer can be found (as may be evidenced by the fact that it was put up for sale immediately in the example cited). Other factors that should be considered include

-whether there are signs that the rental operations were intended to be a new enterprise; or

-whether there are any indications that the corporation decided to take a new direction and not wind-up its operations, such as a change to the corporate charter or a change in ownership.

Paragraph 13 of Interpretation Bulletin IT-73R5, entitled "The Small Business Deduction," discusses the example of a corporation which operates a business and which buys real property for the purpose of using the site in the future as a business premise. In the interim, if rental income is derived, such income would probably be considered to be active business income rather than income from a specified investment business. There would be a presumption that the principal purpose test referred to in the definition of "specified investment business" in subsection 125(7) would not be met for as long as the corporation's principal purpose in owning the site is not to derive rental income from it. Clearly, and as is further discussed in IT-73R5, the principal purpose of a corporation's business must be determined annually after all the facts relating to that business carried on by that corporation in that year have been considered and analyzed. It may not be unreasonable to conclude in some situations that the corporation did not cease to employ its assets in an active business until such time as the land and building are sold. If such a finding is reasonable in the circumstances, that is, that the land and building continue to be employed in an active business, the corporation continues to be an SBC. If this were the case, an election in 1996 would result in a business investment loss. On the other hand, we would point you to the comments in paragraph 4 of Interpretation Bulletin IT-206R, entitled "Separate Businesses," which state that a determination of whether a business has ceased is dependent upon factors such as:

(i)the sale of all inventory,

(ii)dismissal of all employees,

(iii)vacation of business premises.

The sale of all fixed assets of a business is not considered a mandatory requirement for the ceasing of a business if it can otherwise be established to have ceased.

Shares:

In the case of shares, the taxpayer may elect under paragraph 50(1)(b) that the share has been disposed of where the conditions in clauses 50(1)(b)(iii)(A) to (D) are met. If the taxpayer is making the election in 1995, the key issue will be whether the corporation was insolvent at the end of the year. In its ordinary meaning, insolvency refers to an inability to pay debts. The word "insolvent" is not defined for purposes of the Act and therefore should be given its ordinary meaning. Clearly, it would depend on the facts of a particular situation whether a corporation were insolvent at the end of a year.

A determination would be required as to when the corporation ceased to carry on a business. In our example, this may be November, 1995. However, this could otherwise be when the land and building are sold (see our comments above). If it is determined that business ceased when the land and building are sold, the question of whether the rental income is income from property versus (incidental) active business income is not an issue - a corporation is presumed to be in "business," even when it earns property income (i.e. that is not "active"). If this were the situation, no ABIL could be claimed in 1995 in respect of the shares.

If the situation were that the corporation ceased in 1995 to employ its assets in an active business, yet did not cease to carry on business, then no ABIL would be available on the shares in either 1995 or 1996. The corporation would cease to be an SBC in November 1995, so no ABIL on the shares would be available in 1996, since the deemed disposition date of December 31, 1996, would be outside the 12-month period described in the definition of an SBC. At the same time, no ABIL would be available on the shares in 1995, since the requirement in clause 50(1)(b)(iii)(B) that the corporation cease to carry on business would not be met. This result may, in some situations, be contrary to the stated purpose of the modified definition of a SBC in subsection 248(1) for purposes of paragraph 39(1)(c). The 1986 Technical Notes state that the purpose of the modified definition was so that "investors will not be precluded from claiming an allowable business investment loss on the disposition of shares or debt of a small business corporation where it ceases to carry on an active business because it has become bankrupt or is being wound-up prior to the disposition."

To summarize the above comments:

1.If it is determined that the rental income is income from an active business, and the full amount of the debt is bad as of December 31, 1995, then:

(i) the corporation is an SBC throughout the period until the land and building are sold;

(ii) an ABIL on the debt is deductible in 1995 and

(iii) no ABIL may be deducted on the shares until 1996.

If the taxpayer establishes that the debt became bad in 1996 only, an ABIL on the debt would be available in 1996.

2.If it is determined that the rental income is not income from an active business, and the full amount of the debt is established to have become bad in 1995, then:

(i) the corporation ceases to be an SBC in November 1995,

(ii) an ABIL on the debt is deductible in 1995 and

(iii) no ABIL on the shares will be available in 1995 (because the requirement in clause 50(1)(b)(iii)(B) that, at the end of the year, the corporation ceased to carry on business would not be met) or 1996 (because the corporation ceased to be an SBC in November 1995 which would be outside the required 12-month period).

If the taxpayer establishes that the debt became bad in 1996, no ABIL would be available in 1995 or 1996.

Bryan W. Dath
Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch