3 November 2010 External T.I. 2010-0382361E5 - Business Investment Loss

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: Will the shareholder advances to the wholly owned company qualify as business investment losses.

Position: General comments provided.

Reasons: Question of fact..

XXXXXXXXXX
								2010-038236
								S. D'Angelo
								(613)952-5803
November 3, 2010

Dear XXXXXXXXXX

Re: Bad Debt and Business Investment Losses

This is in response to your letter dated September 10, 2010 inquiring whether a shareholder's loan would qualify as bad debt and/or a business investment loss. Our understanding of the situation is as follows:

• Mr. X is the sole shareholder of a corporation (A Inc.).
• During the XXXXXXXXXX taxation year Mr. X advanced funds (Loan) of approximately $XXXXXXXXXX to A Inc. which was evidenced by A Inc. issuing a non-interest bearing note payable to Mr X.
• During the XXXXXXXXXX fiscal year the Loan proceeds were used by A Inc. to help facilitate the purchase of a hotel and other business assets.
• All of the business assets of A Inc., including the hotel, were sold in XXXXXXXXXX to an arm's length purchaser. A Inc. assumed a vendor take back mortgage from the purchaser as partial consideration for the sale. The mortgage receivable was A Inc's. only remaining asset.
• On or around XXXXXXXXXX , A Inc. was unable to collect on its mortgage receivable as the purchaser defaulted, and as a result A Inc. is unable to repay the Loan owing to Mr. X.

Our Comments

The situation outlined in your letter 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 a debt owing 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 that year, subsection 50(1) of the Income Tax Act (Act) provides for a deemed disposition at the end of the year and a reacquisition immediately thereafter at a cost of nil, provided the taxpayer elects in the taxpayer's return of income for the year 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, assuming the debt was acquired by the taxpayer for the purposes of earning income from a business or property, with any recovery of the debt being treated as 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 bad 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."

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) summarize the following factors that usually should be taken into account in determining whether a debt has become bad:

• the history and age of the debt;
• 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;
• changes in total sales as compared with prior years;
• the debtor's cash, accounts receivable and other current assets at the relevant time and as compared with prior years;
• the debtor's accounts payable and other current liabilities at the relevant time and as compared with prior years;
• the general business conditions in the country, the community of the debtor, and in the debtor's line of business; and
• the past experience of the taxpayer with writing off bad debts.

The FCA noted that the above factors are not exhaustive and, in different circumstances, one factor or another may be more important.

In order for a taxpayer's loss from a property that is a debt to qualify as a "business investment loss" (a BIL), as defined in paragraph 39(1)(c) of the Act, it must, inter alia, result from the disposition of a debt owing to the taxpayer, including a debt by a "small business corporation". The term "small business corporation" (SBC) is defined in subsection 248(1) of the Act. In general terms, an SBC, at a particular time, is a Canadian-controlled private corporation all or substantially all of the fair market value of the assets of which, at that time, is attributable to assets used principally in an active business carried on primarily in Canada by the corporation or a related corporation, to shares or debts of connected SBCs, or to a combination of the two. In addition, for purposes of determining a BIL from a disposition, an SBC includes a corporation that was an SBC at any time in the 12 months before the disposition. For additional information on these rules please refer to Interpretation Bulletin, IT-484R2, Business Investment Losses.

Accordingly, whether a loss on a disposition of the Loan made by Mr. X to A Inc. would qualify as a BIL is a question of fact that depends, inter alia, on the status of the A Inc. as an SBC at the time of disposition or in the preceding 12 months at the time the Loan is considered to have become a bad debt under the rules in subsection 50(1) of the Act.

Lastly, we would also like to point out that where the rules in subsection 50(1) of the Act apply the debt forgiveness rules in subsection 80 of the Act may apply to the debtor corporation. While a discussion of these rules is beyond the scope of this response we wanted to make you aware of their potential application

Since your situation involves the interpretation of relatively complex provisions of the Act, you may wish to consider obtaining professional advice in order to best plan your tax affairs.

We trust our comments will be of assistance.

Yours truly

S. Parnanzone
For Director
Business and Partnership Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch