| September 1, 1989 | |
| TORONTO DISTRICT OFFICE | Small Business and |
| Internal Audit | General Division |
| Chief | Bill Guglich |
| M. Mihaly | (613) 957-2102 |
| Attention: L.F. Shepherd | File No. 7-4144 |
Subject: Deductibility of Allowance Business Investment Loss and Subsequent Carrying Charges
This is in reply to your letter of July 18, 1989, concerning a taxpayer's deduction of an allowable business investment loss and subsequent carrying charges.
You described a situation where in 1986, a guarantor was required to discharge a loan owed by her husband's wholly owned corporation. The funds used to honour the guarantee were borrowed by way of a mortgage on the guarantor's principal residence. The guarantor's only relationship with the corporation was that of a spouse of the sole shareholder. There were no agreements, nor were any contemplated between the guarantor and the corporation respecting any consideration in exchange for the guarantee. The guarantor is not, nor was ever, a shareholder of the corporation and did not advance any funds to the corporation. The guarantor subsequently separated from her spouse.
The guarantor's position is that, although she was not a shareholder or investor in the company, by virtue of common law and family law reform she is in fact a beneficial shareholder and entitled to an equal share in the corporation which makes her eligible for a deduction in respect of the amount paid to honour her guarantee and in respect of the subsequent carrying charges.
The Department's position as stated in paragraph 3 of IT-239R2 is that a capital loss arising from honouring a guarantee given for inadequate or for no consideration is nil by virtue of subparagraph 40(2)(g)(ii) of the Act. The Department has, however, adopted the position with respect to Canadian corporations of which the taxpayer is a shareholder that it will allow a loss as stated in paragraph 6 of IT-239R2 where certain conditions are met.
As the guarantor is not a shareholder of the corporation the position described in paragraph 6 of IT-239R2 does not apply in her case. The matter of whether she is a shareholder of the corporation is a question of fact. She cannot be considered a shareholder on the basis of contingent provisions in family law reform. We therefore agree with you that the guarantor is not entitled to a deduction respecting the loss arising from honouring the guarantee.
The subsequent carrying charges respecting borrowed funds to discharge the loan would also not be deductible as the guarantor did not receive any consideration for the guarantee and therefore the expenditures would not be considered to be for the purpose of producing income.
We trust this will be of assistance to you.
for DirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch