Principal Issues: Various questions relating to the deduction of a business investment loss in a given hypothetical situation.
Position: None. General comments.
Reasons: Question of fact.
XXXXXXXXXX 2017-068434
April 13, 2023
Dear Ms. XXXXXXXXXX,
Subject: Business investment loss
This letter is in response to Mr. XXXXXXXXXX's fax of January 21, 2017 in which he requested our comments regarding the deduction of a business investment loss ("BIL") in the following hypothetical situation.
An individual is the sole shareholder of a corporation that operates a restaurant as a franchisee. In 20X1, the corporation took legal action against the franchisor and, at the same time, closed the restaurant. The individual had made advances to the corporation over the years the restaurant was in operation totalling $100,000 (the "Debt"). At the time of the restaurant's closure in 20X1, the corporation did not have the liquidity to repay the Debt. However, the corporation may be able to repay the Debt if it is successful in its lawsuit against the franchisor. According to the corporation's legal advisors, there is a high probability that the corporation will be successful at trial. However, assume that in 20X6, the court finds in favour of the franchisor so that no amount resulting from this lawsuit will be paid to the corporation.
In order to help determine in the hypothetical situation submitted when the individual could claim a deduction for a BIL in computing his income in respect of the Debt, we have been asked to comment, with reference to Canada (Attorney General) v. Poulin1, on whether the corporation was still carrying on the restaurant business in 20X6 despite the closure of the restaurant in 20X1.
In addition, in the event that a proposal is filed with the corporation's creditors under which the individual would assign his Debt for the sum of one dollar to the corporation's other creditors with whom he is not related, we are asked to comment on whether the individual has disposed of the Debt to persons with whom he deals at arm's length.
Please note that for the purposes of our comments, we have assumed that the Debt was acquired by the individual for the purpose of earning income from a business or property. If this is not the case, any loss resulting from the disposition of the Debt is deemed to be nil by virtue of subparagraph 40(2)(g)(ii), which provides that a taxpayer's loss from the disposition of property is nil where it is, among other things, a loss from the disposition of a debt unless the debt was acquired by the taxpayer for the purpose of gaining or producing income from a business or property.
All statutory references herein are to the provisions of the Income Tax Act (the "Act").
Our Comments
This technical interpretation provides general comments about the provisions of the Act and related legislation. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC70-6R12, Advance Income Tax Rulings and Technical Interpretations.
In sum, paragraph 39(1)(c) provides that a capital loss incurred by a taxpayer may be a BIL if it results from the disposition of any property to which subsection 50(1) applies or to a person with whom the taxpayer was dealing at arm's length. Where the property disposed of is a debt in favour of the taxpayer, the debt must be, at the time of the disposition, a debt owing to the taxpayer by a Canadian-controlled private corporation that is a small business corporation (an "SBC").
Subsection 248(1) defines the term "SBC" as including 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 that are used principally in an active business carried on primarily in Canada by the particular corporation or by a corporation related to it.
The definition of SBC in subsection 248(1) also provides that, for the purposes of paragraph 39(1)(c), an SBC includes a corporation that was an SBC at any time in the 12-month period preceding that time.
For general information on the question of whether or not a taxpayer has ceased to carry on a business in this regard, paragraph 4 of Interpretation Bulletin IT-206R, Archived - Separate Businesses,2 states, among other things, that this question depends on factors such as the sale of all inventory, dismissal of all employees or the vacation of business premises.
In addition, paragraph 2 of Interpretation Bulletin IT-313R2, Archived - Eligible Capital Property - Rules Where a Taxpayer Has Ceased Carrying on a Business or Has Died3, states that the facts of the particular case determine whether or not the taxpayer has ceased carrying on a business. This generally occurs when the taxpayer has ceased the normal activities of the business with little likelihood of starting them up again in the near future.
In the Poulin decision to which the request refers, the issue was whether compensation paid by a broker in satisfaction of a judgment was deductible in computing the taxpayer's business income pursuant to paragraph 18(1)(a), given that the broker had completely ceased carrying on business as a broker. Following this decision, we accept the principle that an amount for damages may be deducted in a year in which a taxpayer no longer carries on business, since the taxpayer is presumed not to have ceased carrying on business for as long as the taxpayer is engaged in following up on acts committed to by the taxpayer in the course of the business, even if, at the time the amount is deducted, the taxpayer is no longer transacting and can no longer attend to the taxpayer’s customers.
Determining whether or not a taxpayer has ceased carrying on a business is a question of fact that can only be resolved after a detailed analysis of all the circumstances of each situation. Consequently, we cannot give a technical interpretation of this issue.
That said, in the hypothetical situation submitted, the individual's ability to claim a BIL pursuant to paragraph 39(1)(c) does not depend solely on whether the corporation carries on a business at the time of the disposition of the Debt or during the 12-month period preceding that time.
As stated above, to be an SBC, all or substantially all of the fair market value of the corporation's assets must be attributable, at a particular time, to assets that are used principally in an active business carried on by the corporation primarily in Canada.
In addition, in order for the loss to result from the disposition of any property to which subsection 50(1) applies, a taxpayer must, among other possibilities, establish that a debt owing to the taxpayer at the end of a taxation year has been determined pursuant to paragraph 50(1)(a) to be a bad debt in the year.
The application of subsection 50(1) and the question of whether a corporation is an SBC at a particular time are questions of fact that must be resolved in light of a full examination of all the relevant facts. Consequently, we are unable to express a view in the context of this request for interpretation on the question of when, if at all, the individual could claim the deduction of a BIL in computing his income in respect of the Debt.
If it is determined that the individual did not claim a BIL deduction in computing income in respect of the Debt in the year in which it arose pursuant to subsection 50(1), the individual may claim relief for a late or amended election. Pursuant to subsection 220(3.2), the Minister of National Revenue has the discretionary power to extend the time limit for filing certain elections. The list of elections referred to in subsection 220(3.2) is found in section 600 of the Income Tax Regulations (the "Regulations"). The election provided for in subsection 50(1) is an election referred to in section 600 of the Regulations.
Finally, as adverted to above, a BIL may also result pursuant to paragraph 39(1)(c) from the disposition of any property to a person with whom the taxpayer was dealing at arm's length.
We are unable to comment in a technical interpretation on the possibility, in the hypothetical situation presented, of a proposal to the creditors of the corporation under which the individual would assign his Debt for the sum of one dollar to the other creditors with whom he was not related. Assuming that such an assignment of the Debt occurred, paragraph 251(1)(c) provides that the question of whether unrelated persons deal at arm's length at a particular time is one of fact. This question can therefore only be resolved after a detailed examination of the circumstances of each situation.
However, we refer you to our general position set out in paragraphs 1.37 to 1.44.1 of Income Tax Folio S1-F5-C1, Related Persons and Dealing at Arm's Length,4 regarding the question of whether unrelated persons (other than trusts) are dealing at arm's length.
In particular, paragraph 1.41 of this Folio indicates that failure to carry out a transaction at fair market value may be indicative of a non-arm's-length transaction. However, such failure is not conclusive. Conversely, the fact that a transaction between unrelated persons at fair market value does not necessarily indicate an arm's-length situation. The key factor is whether there are separate economic interests which reflect ordinary commercial dealings between parties acting in their separate interests. A situation where one party to a transaction is merely accommodating the other party in an attempt to obtain a certain tax result may be a situation where the parties are not dealing at arm's length because they do not have separate economic interests which reflect ordinary commercial dealings between parties acting in their own separate interests.
Best regards,
Isabelle Landry
Manager
Business and Employment Income Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
Footnotes:
1. 96 DTC 6477 (F.C.A.)
2. CANADA REVENUE AGENCY, Interpretation Bulletin IT-206R (archived), "Separate Businesses", October 29, 1979.
3. CANADA REVENUE AGENCY, Interpretation Bulletin IT-313R2 (Archived), "Eligible Capital Property - Rules Where a Taxpayer Has Ceased Carrying on a Business or Has Died", April 21, 1995.
4. CANADA REVENUE AGENCY, Income Tax Folio S1-F5-C1, "Related Persons and Dealing at Arm's Length," November 24, 2015.