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.
Principal Issues: What is the amount of the bad debt at the end of year 1.
Position: General comments
Reasons: Insufficient information
XXXXXXXXXX
2010-038082
S. D'Angelo
(613)952-5803
October 22, 2010
Dear XXXXXXXXXX :
Re: Bad Debts
This is in response to your e-mail dated September 17, 2010, inquiring whether a shareholder's loan is a bad debt.
Our understanding of the situation is as follows:
- Mr. and Mrs. X are the sole shareholder's of a Canadian-controlled private corporation (Corp A) that is a small business corporation as defined in subsection 248(1) of the Income Tax Act (Act).
- Mr. and Mrs. X have advanced a loan of approximately $50,000 to Corp A. At the end of Year 1 Corp A has the following:
- Loan payable to Mr. and Mrs. X of $50,000
- Other liabilities to suppliers of approximately $30,000
- Estimated value of Corp A's assets are $5000
- During Year 2 some of Corp A's assets were sold for $3,500 and the funds were paid directly to the shareholders. During Year 2 the shareholders have advanced additional funds of approximately $10,000 to Corp A.
At issue is whether there is an amount of bad debt at the end of Year 1 in respect of Corp A's loan payable to Mr. and Mrs. X. It is your view that the capital loss that would arise in respect of the amount of bad debt would qualify as a business investment loss, as defined in paragraph 39(1)(c) of the Act. You have laid out the following three possible amounts of bad debts at the end of Year 1:
1. $45,000 ($50,000 less $5,000).
2. $46,500 ($50,000 less $3,500, which is the actual amount recovered from the sale of assets).
3. $50,000.
Our Comments
The situation outlined in your e-mail appears to relate to a factual one, involving a specific taxpayer. It is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advanced income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other CRA publications can be accessed on the internet at http://www.cra-arc.gc.ca. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office ("TSO") for their views. A list of TSOs is available on the "Contact Us" page of the Canada Revenue Agency (CRA) website. Although we cannot comment on your specific situation, we are prepared to provide the following general comments, which may be of assistance.
Where a taxpayer establishes that an amount receivable on capital account (other than a debt owing in respect of the disposition of personal-use property) at the end of a taxation year has become a bad debt in the taxation year, subsection 50(1) of the Act provides for a deemed disposition at the end the year and a reacquisition immediately thereafter at a cost of nil, provided the taxpayer makes an election to have subsection 50(1) of the Act apply in respect of the debt. This normally results in a bad debt being a capital loss for the year with any recovery of the debt being a capital gain.
The CRA's position with respect to capital debts that are bad is outlined in Interpretation Bulletin IT-159R3, Capital Debts Established to be Bad Debts. Paragraph 10 of the bulletin states:
"The time at which a debt becomes a bad debt is a question of fact and any decision made must be dependent upon the circumstances in each case. A determination by a creditor that a debt has become bad in a particular taxation year must be supported by all relevant and material facts. Generally, a debt will not be uncollectible at the end of a particular taxation year unless the creditor has exhausted all legal means of collecting it or where the debtor has become insolvent and has no means of paying it. A debt is considered bad for the purpose of section 50 only when the whole amount is uncollectible or when a portion of it has been settled and the remainder is uncollectible. Otherwise, where a portion of a debt can be considered uncollectible, this portion is not considered to be a bad debt for the purpose of section 50 even though accounting practice may require a write-down to realizable value. Where an amount owing by one debtor consists of more than one debt, each debt is considered separately in determining the extent to which the above comments apply. For example, one debt may be secured and collectible whereas another debt may be unsecured and uncollectible and, therefore, qualify as a bad debt." (Emphasis added)
Whether a debt is a bad debt in a particular case is a question of fact to be resolved by reviewing the documents and other circumstances of the case. Factors to be considered are varied. In Rich v The Queen, 2003 DTC 5115, the Federal Court of Appeal (FCA) commented as follows regarding the relevant factors:
"[12] The assessment of whether a debt is bad is one based upon the facts at a particular point in time, i.e. December 31, 1995. The Income Tax Act does not prescribe factors to be considered in assessing the collectibility of a debt. However, Tax Appeal Board judgments in Hogan v. The Minister of National Revenue, 56 DTC 183 and No. 81 v. The Minister of National Revenue, 53 DTC 98, suggest some of the factors to be taken into account. After the creditor personally considers the relevant factors, the question is whether the creditor honestly and reasonably determined the debt to be bad.
[13] I would summarize factors that I think usually should be taken into account in determining whether a debt has become bad as:
1. the history and age of the debt;
2. the financial position of the debtor, its revenues and expenses, whether it is earning income or incurring losses, its cash flow and its assets, liabilities and liquidity;
3. changes in total sales as compared with prior years;
4. the debtor's cash, accounts receivable and other current assets at the relevant time and as compared with prior years;
5. the debtor's accounts payable and other current liabilities at the relevant time and as compared with prior years;
6. the general business conditions in the country, the community of the debtor, and in the debtor's line of business; and
7. the past experience of the taxpayer with writing off bad debts.
This list is not exhaustive and, in different circumstances, one factor or another may be more important.
14] While future prospects of the debtor company may be relevant in some cases, the predominant considerations would normally be past and present. If there is some evidence of an event that will probably occur in the future that would suggest that the debt is collectible on the happening of the event, the future event should be considered. If future considerations are only speculative, they would not be material in an assessment of whether a past due debt is collectible."
The information provided regarding your scenario is not sufficient for us to conclude that Mr. and Mrs. X's loan to Corp A, either in full or in part, is a bad debt at the end of Year 1. As indicated in IT-159R3, a debt is considered bad for the purpose of section 50 only when the whole amount is uncollectible or when a portion of it has been settled and the remainder is uncollectible. It does not appear that a portion of Mr. and Mrs. X's loan (i.e., the amount equal to the expected recovery) has been settled at the end of Year 1 with the remainder being uncollectible.
One may take the view that Mr. and Mrs. X's loan may not in fact be bad at the end of Year 1 because the shareholders have advanced additional funds of $10,000 to Corp A during Year 2. As also mentioned by the FCA in the Rich case, while the predominant considerations for determining whether a debt is bad would normally be past and present facts, future prospects may be relevant in some cases such as one involving a loan by a shareholder to his or her closely held corporation. Based on the facts, it is unclear why Mr. and Mrs. X would be lending more money to Corp A if it cannot repay the outstanding loans. In Sunatori v The Queen, 2010 DTC 1234, the Tax Court of Canada commented as follows after referring to another case, Giahinejad v. The Queen, 2002 DTC 3830, dealing with the issue of whether a taxpayer can assert that a company cannot repay its debt when the taxpayer is still lending it money:
"[54] Similarly, in Giahinejad, it is implicit that the future potential for collection is relevant. Making advances implicitly suggests something positive in the future which contradicts a bad debt determination at the time of the advance. Following that rationale, a loan not due for some time cannot reasonably be found to be bad today, where the prospects of collection when due are promising as shown by recent advances and by the commitment and drive and ongoing work of the debtor whose actions reflect no sign of an imminent failure of the business.
[55] All this is to say that just because the Appellant was satisfied that the loans could not be repaid at the end of the years in question, does not mean it was reasonable to consider that they were bad. If it was, then all temporary, short term, insolvency situations would lead to an explosion of bad debt claims. Nothing in the language of the subject provisions warrants such an explosion."
We trust our comments will be of assistance.
Yours truly,
S. Parnanzone
Manager
For Director
Business and Partnership Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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