22 August 1989 Income Tax Severed Letter AC58174 - Bad Debts

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.

19(1)                                   5-8174
                                        S. Short
                                        (613)957-2134

August 22, 1989

Dear Sirs:

Re: Subsection 50(1) and subparagraph 40(2)(g)(ii) of the Income Tax Act (the "Act")

This is in reply to your correspondence dated may 30, 1989 wherein you have requested an interpretation of the application of the above mentioned sections of th Act, with particular regard to paragraph 6(c) of interpretation bulletin IT-239R2 .

Our understanding of your situation is as follows:

                          24(1)

You have expressed concern that the provisions of subparagraph 40(2)(g)(ii) of the Act will deem the loss arising from the inability of the corporation to repay any part of the shareholders advances to be nil for two reasons:

1)       The shareholders' advances were non-interest bearing,
         hence it is not generally accepted that the loan was
         made for the purpose of gaining or producing income, and

2)       Revenue Canada Taxation's administrative practice is to
         not apply the provisions of subparagraph 40(2)(g)(ii) of
         the Act if all of the conditions outlined in
         interpretation bulletin  IT-239R
 paragraph 6 are
         satisfied, and these conditions cannot be met in 1988 as
         the corporation did not cease operations until 1989. 
         Further, because subsection 50(1) of the Act implies that
         a bad debt may only be deducted in the year it becomes bad
         (1988), no loss is available in 1989 either.

You have asked whether, in the above situation, Revenue Canada would allow a loss to be recognized in 1988 without the application of subparagraph 40(2)(g)(ii) of the Act or alternatively, allow the loss to be recognized in 1989 even though the debt could be considered to have become bad in 1988.

The technical application of the provisions of subparagraph 40(2)(g)(ii) would correctly deem the shareholders' loss to be nil as the advances were not made for the purpose of gaining or producing income from business or property. The criteria necessary to administratively not have the provisions of subparagraph 40(2)(g)(ii) (apply in a situation where a share holder has loaned money at no interest to his Canadian corporation are not met as the corporation did not cease to carry on its business in 1988, the year the debt was apparently established to have become bad.

You have made reference in your letter to the Tax Court of Canada case of Fritz v MNR 85 DTC 507 as confirming that a debt can be considered bad even though the corporation is still operating. The department has appealed this case as it does not concur with the Court's acceptance that the taxpayer's particular circumstances brought him under the "excepting" provisions of subparagraph 40(2)(g)(ii) of the Act. We do not accept that when a shareholder incurs a debt with his corporation he does so to indirectly derive income from business or property through the preservation of his shares. Our position is supported by the Supreme Court decision in Canada Safeway Limited v. MNR, 5 DTC 1239, and the Exchequer Court of Canada decision in D.W.S. Corporation V. MNR 68 DTC 5045.

The question of when a debt becomes bad is a question of fact determined in accordance with the circumstances of each case. The determination is necessarily a matter of business judgment. You may wish to explore the possibility that the bad debt could be considered to have become bad in 1989 when the assets were sold to pay down existing debts of the corporation. As this decision is based on fact we would recommend you discuss the matter with your local district taxation office (36 Adelaide St. East, Toronto). We trust the above comments are of some assistance to you and regret that our reply could not be more favourable.

Yours truly,

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch