26 June 2003 External T.I. 2003-0007255 - ABIL-SPECIFIED INVESTMENT BUSINESS

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Whether a corporation carried on an active business for the purposes of claiming an ABIL pursuant to clause 39(1)(c)(iv)(A).

Position: Question of fact, but likely not.

Reasons: The corporation's income earning activities has consisted solely in renting the properties it owned during the relevant taxation years. It did not meet the exceptions in par.(a) or (b) of the definition of Specified Investment Business in ss. 125(7). It was therefore not carrying on an active business.

XXXXXXXXXX 2003-000725

P. Massicotte, CA, M.Fisc.

June 26, 2003

Dear XXXXXXXXXX:

Re: Allowable Business Investment Loss

This is in response to your letter sent by fax on March 7, 2003 requesting our comments in connection with the definition of "small business corporation" in subsection 248(1) of the Income Tax Act (the "Act"), as it relates to a claim for an allowable business investment loss in the factual situation submitted to us.

The facts as we understand them are as follows:

1. You are the sole shareholder of a corporation that has ceased its activities since XXXXXXXXXX. The corporation has never been related nor associated with any other corporation and has never employed more than 5 full-time employees. The corporation has at all times been a Canadian-controlled private corporation, as defined in subsection 125(7) of the Act.

2. You acquired 50% of the common shares from treasury in XXXXXXXXXX, upon incorporation. You acquired the other 50% interest from XXXXXXXXXX at some time during the year XXXXXXXXXX.

3. You made loans (the "shareholder loans") to the corporation throughout the years it was in operation, i.e. from XXXXXXXXXX to XXXXXXXXXX. These funds were used in the corporation's activities to earn income. A balance of $XXXXXXXXXX remained unpaid after the corporation ceased its activities in XXXXXXXXXX and has never been recovered.

4. Throughout the years the corporation was in operation, its assets have exclusively consisted of a co-ownership interest in XXXXXXXXXX properties in XXXXXXXXXX.

5. XXXXXXXXXX.

6. XXXXXXXXXX.

7. XXXXXXXXXX.

8. XXXXXXXXXX.

9. The corporation's income throughout the time it was in operation, i.e. XXXXXXXXXX to XXXXXXXXXX, has therefore consisted exclusively of its share of rental income for the use of these XXXXXXXXXX properties. XXXXXXXXXX, were ever listed for sale and no attempts were made by the co-owners to sell XXXXXXXXXX prior to the events described below occurred.

10. XXXXXXXXXX.

11. Mortgage payments could no longer be made by the co-owners in respect of the properties they co-owned and, in XXXXXXXXXX, the bank that provided the permanent financing for XXXXXXXXXX properties threatened to foreclose, unless the properties were sold.

12. As a result, a distress sale of XXXXXXXXXX properties was completed in XXXXXXXXXX and by XXXXXXXXXX all debts had been discharged, except the shareholder loans. The corporation had no assets after that time and no other activities were carried on since that time. We have not been provided with any information as to how any gain or loss on the sale of XXXXXXXXXX properties was reported.

13. At no time has the corporation been declared a bankrupt, nor has a winding-up order been issued under the Winding-Up and Restructuring Act in respect of the corporation.

As no payment has been received in connection with the shareholder loans and none are expected, you wish to claim a loss for the unpaid amount of those loans. You ask whether the corporation could be considered a "small business corporation", as defined in subsection 248(1) of the Act, for the purpose of determining a business investment loss pursuant to paragraph 39(1)(c) of the Act. You also ask in what year the loss should be claimed.

Your comments

You mention that the intention of the corporation was to develop XXXXXXXXXX properties in which it had a co-ownership interest for their resale, even though it actually earned only rental income during the years in question. More specifically, you mention that the XXXXXXXXXX. It was your intention to sell XXXXXXXXXX properties together once the XXXXXXXXXX was completed.

Our Comments

As explained in Information Circular 70-6R5 dated May 17, 2002, it is this Directorate's policy to provide written confirmation of the tax implications inherent in particular transactions only where an advance-ruling request is submitted in respect of proposed transactions. In order to determine whether a loss in a particular situation can be treated as an allowable business investment loss, it is necessary to review all the relevant facts and documentation. Such a review falls within the responsibility of your local Tax Services Office. However, we are prepared to provide you with the following general comments.

The Canada Customs and Revenue Agency's ("CCRA") position on business investment losses is set out in Interpretation Bulletin IT-484R2, Business Investment Losses, which you can find on our website at: www.ccra-adrc.gc.ca. Subparagraph 39(1)(c)(iv) of the Act provides that a business investment loss may arise from the disposition of a debt by an individual if it is owing by a Canadian-controlled private corporation and disposed of to an arm's length person, or deemed to have been disposed of as a result of an election made pursuant to subsection 50(1) of the Act.

Subsection 50(1) allows a taxpayer to elect to be deemed to have disposed of a debt (other than a debt from the sale of personal-use property) at the end of a taxation year for nil proceeds and to have reacquired it immediately thereafter at a cost of nil, provided the debt is owed to the taxpayer at the end of the taxation year and it is established by the taxpayer to have become a bad debt in the year. The election must be made in the return of income for the year the debt became bad.

In that respect, paragraph 10 of Interpretation Bulletin IT-159R3, Capital debts established to be bad debts, states that 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. Moreover, a debt is considered bad for the purpose of section 50 of the Act only when the whole amount is uncollectible or when a portion of it has been settled and the remainder is uncollectible.

In addition, for a loss on a debt to be considered a business investment loss, subparagraph 39(1)(c)(iv) of the Act provides that the corporation owing the debt must meet one of the conditions in clauses 39(1)(c)(iv)(A) to (C) at the time of the disposition (or deemed disposition). Unless the corporation has been declared a bankrupt (clause (B)), or has been issued a winding-up order under the Winding-Up and Restructuring Act (clause (C)), it must be a small business corporation at the time of the disposition (or deemed disposition), pursuant to clause 39(1)(c)(iv)(A). The term "small business corporation" is defined in subsection 248(1) of the Act. In general, a small business corporation at any 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, or shares or debts of connected small business corporations, or a combination of the two. In our view, "all or substantially all" means at least 90% of the fair market value of the assets must be attributable to assets used principally in an active business. For the purposes of determining a business investment loss, the definition of small business corporation also includes a corporation that was a small business corporation at any time in the 12 months preceding the particular time.

Subsection 248(1) of the Act defines "active business" in relation to a taxpayer resident in Canada as any business carried on by the taxpayer other than a specified investment business or a personal services business. The expression "specified investment business" is defined in subsection 125(7) of the Act, and means "a business (other than...a business of leasing property other than real property) the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property but...does not include a business...where

(a) the corporation employs in the business...more than 5 full-time employees, or

(b) any other corporation associated with the corporation provides...managerial, administrative... or other similar services to the corporation...and the corporation could reasonably be expected to require more than 5 full-time employees if those services had not been provided".

Accordingly, for the corporation to be considered at any time a "small business corporation", it must be determined inter alia whether all or substantially all of the fair market value of its assets at that time is attributable to assets used principally in an active business it carries on. If all of the corporation's activities fall within the definition of "specified investment business", it cannot be considered to carry on an active business, and as a result cannot be considered a small business corporation for the purposes of paragraph 39(1)(c) of the Act. A loss on the disposition (or deemed disposition) of a debt owing by such a corporation cannot be considered a business investment loss.

In the present situation, the corporation is no longer carrying on any business and has not carried on any business in the preceding 12 months. It cannot therefore be considered a small business corporation at the present time, and any loss from the disposition (or deemed disposition) of the shareholder loans at the present time would not be considered a business investment loss. Although a review of all facts would be required to conclusively resolve the issue, based on the limited facts submitted, it appears the shareholder loans may have become bad debts during the year XXXXXXXXXX, or XXXXXXXXXX . We note however that no election has been made under subsection 50(1) of the Act in respect of those years. Under certain circumstances, a taxpayer may apply pursuant to subsection 220(3.2) of the Act, and paragraph 600(b) of the Income Tax Regulations, to have an election described in subsection 50(1) of the Act filed late. The guidelines followed by the CCRA are outlined in Information Circular 92-1, Guidelines for accepting late, amended or revoked elections, which you can also find on our website. Where an election can be made pursuant to subsection 50(1) of the Act, the above corporation must have been a small business corporation at the time of the deemed disposition, that is, at the end of the year in respect of which an election is made (the year in which the debt became bad), or in the 12 preceding months, to result in a business investment loss.

It is a question of fact whether at any time a corporation carries on an active business or a specified investment business, which can only be determined after an examination of all relevant facts in a particular situation. Furthermore, it is possible for a corporation to carry on more than one business simultaneously. As mentioned in paragraph 2 of Interpretation Bulletin IT-206R, Separate Businesses, whether the carrying on of two or more simultaneous business operations by a taxpayer is the same business is dependent upon the degree of interconnection, interlacing or interdependence and the extent of the unity embracing the business operations.

You suggest the corporation in the situation described above should be considered to be carrying on an active business, and not a specified investment business, because it was the intention of the owners to develop the properties it co-owned for resale. As indicated in paragraphs 12 to 14 of Interpretation Bulletin IT-73R6, The Small Business Deduction, it is the "principal purpose" of the business that must be considered for the purposes of the definition of "specified investment business" in subsection 125(7) of the Act. In our view, this refers to the main or chief objective for which the business is carried on. Moreover, 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. Included in this evaluation should be such things as:

(a) the purpose for which the business was originally commenced;

(b) the history and evolution of its operations, including changes in its mode of operation and purpose of existence; and

(c) the manner in which the business is conducted.

You refer to the decision of the Tax Court of Canada under the Informal Procedure in the case of Fautley v. The Queen, 2002 DTC 3887, to support your views. In that case, the corporation attempted to sell a property and entered into an agreement that granted a potential buyer an option to acquire the property. The potential buyer could not raise the necessary funds but was permitted to keep possession of the property on the basis of paying a monthly rent. The corporation later took possession of the property and sold it. The court ruled in that case that the rent was part of the arrangement made by the corporation to sell the property, and accepted the fact the principal purpose of the business was not to derive rental income. By contrast, the Tax Court in the case of Gill v. MNR, 98 DTC 2048, XXXXXXXXXX. In that case, the taxpayer constructed a shopping plaza in 1990 and entered into leases with the goal of selling the plaza when it was substantially leased. The corporation became bankrupt and lost its property in 1993. The issue was whether the corporation could be considered a small business corporation for the purposes of claiming an allowable business investment loss in respect of debts owing to the shareholders at the time it became bankrupt.

In considering the principal purpose of the corporation's business for the purposes of the definition of "specified investment business" in subsection 125(7) of the Act, the court referred to previous decisions and in particular to comments made in the case of Prosperous Investments Ltd v. MNR, 92 DTC 1163, with reference to Ben Barbary Co. v. MNR, 89 DTC 242 (TCC), which set out at page 244:

In determining the "principal purpose" of a business carried on by a corporation the stated object of the person who carries it on is not necessarily the only, or even the most important, criterion. Of critical importance is what the corporation in fact does and what its sources of income are.

The court noted in the case of Gill that the income earned by the corporation during the years it was in operation consisted exclusively in rental income and interests on the rental deposits (except for a management fee in one year), and that no attempt was made to sell the property as soon as it was substantially leased. The court concluded in light of those facts that the corporation's principal purpose was to derive income from the property for those years, and was therefore carrying on a specified investment business rather than an active business. The corporation was therefore not a small business corporation and its shareholders were not entitled to a business investment loss in connection with their loans.

Similarly, in the present situation we would note that the only income earned by the corporation throughout the many years it was in operation was from rental activities, and that it does not appear that any attempt was made to sell XXXXXXXXXX, or any of its properties, prior to the bank indicating its intention to foreclose on the mortgage. Accordingly, based on the limited information provided, it would appear that the corporation was carrying on a specified investment business and any loss relating to the shareholder loans would not qualify as an allowable business investment loss.

We trust the above comments are of assistance to you.

Yours truly,

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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