G. Thornley (613) 957-2130
October 2, 1986
Dear Sirs:
Re: Paragraphs 20(1)(1) and (p) of the Income Tax Act (the "Act")
This is in reply to your letter of July 9, 1986, requesting a technical interpretation relating to the application of the above-noted paragraphs. We regret the delay in replying to your letter.
You describe a situation whereby a taxpayer in the process of selling all or substantially all of the assets of a business to a person who proposes to continue the business also sells all remaining accounts receivable. The vendor and purchaser make an election under section 22 in respect of the accounts receivable. A condition of the sale requires the original vendor to reacquire any uncollectable accounts receivable in the year that such debts have become bad debts. You are of the view because they were included in income in the year or previous year that the original vendor may claim a reserve under paragraph 20(1)(l) or may write- off under paragraph 20(l)(p) an amount in respect of the reacquired accounts receivable.
Our comments
Generally speaking, we are of the view that when accounts receivable are sold or as in the present instance reacquired, in circumstances such that an election under section 22 has not been made, that such a sale or reacquisition is in respect of capital property. (See paragraph 18 of IT-442 ). Consequently when the original vendor reacquires the uncollected portion of accounts receivable, as in your example, he will not be entitled to a deduction pursuant to either of the above-noted paragraphs in computing his income from the business for the taxation year in which the accounts receivable are established to be doubtful or bad debts, unless he is a trader in accounts receivable. Additionally, as there is the presumption that a taxpayer selling all or substantially all of the property used in carrying on the business has ceased to carry on the business there is the question of source of income from which to deduct the allowance for bad debts or the bad debts themselves.
A taxpayer may claim as a deduction from a business or property such amounts as are wholly applicable to that source or such part as may reasonably be regarded as applicable there to. In our view the reacquired debts are no longer attributable to the taxpayer's business or property. They are attributable to the acquisition of capital property and thus subject to the rules in subsection 50(1) of the Act.
We trust our comments will prove helpful.
Yours truly,
ORIGINAL SIGNED BY
Wm. R. McColm
for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch