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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
As part of a proposal, a shareholder-creditor had non-interest-bearing advances for which he received XXXXXXXXXX% of the amount of his advances pursuant to the Bankruptcy and Insolvency Act. The corporation did not cease carrying on business.
1. Can the shareholder-creditor claim a capital loss?
2. If so, can this capital loss be claimed as a business investment loss for the purposes of paragraph 39(1)(c) of the Act?
Position:
1. Yes, he can claim a capital loss.
2. No. The conditions of paragraph 39(1)(c) are not satisfied.
Reasons:
1. We accepted the reasoning of the Federal Court of Appeal in Edwin J Byram.
2. Subsection 50(1) does not apply. Furthermore, the shareholder did not dispose of his claim to a person with whom he was dealing at arm's length.
June 7, 2001
Shawinigan-south Tax Centre Headquarters
Danielle Bouffard
(613) 957-8953
Attention: Mr. Jean Chorel
2000-006074Business investment loss deduction
This is in response to your fax of December 8, 2000 and your faxes of April 4 and 12, 2001 requesting our opinion on the above subject.
The facts were given to us by representatives of the taxpayer XXXXXXXXXX and are summarized as follows:
1. XXXXXXXXXX (the "Shareholder") owned XXXXXXXXXX% of the common shares of XXXXXXXXXX Corporation (the "Corporation"). The Corporation was a "Canadian-controlled private corporation" as defined in subsection 125(7) of the Income Tax Act (the "Act"). The Corporation's fiscal period was XXXXXXXXXX.
2. For various years, the shareholder had made non-interest-bearing advances to the Corporation, the balance of which as at XXXXXXXXXX was $XXXXXXXXXX.
3. On XXXXXXXXXX the Corporation, being unable to meet its financial obligations, filed a notice of intention to make a proposal under section 50.4 of the Bankruptcy and Insolvency Act (the "Bankruptcy Act"). A proposal under Part III of the Bankruptcy Act was filed on XXXXXXXXXX. The advances made by the shareholder were included in the proposal.
4. Pursuant to the proposal, the ordinary creditors received XXXXXXXXXX% of the amount of their claim. The shareholder therefore received two amounts totalling $XXXXXXXXXX on account of advances.
5. The shareholder calculated a business investment loss ("BIL") for the XXXXXXXXXX taxation year as follows:
Proceeds of disposition $XXXXXXXXXX
Adjusted cost base (XXXXXXXXXX)
BIL (XXXXXXXXXX)
ABIL (3/4) $(XXXXXXXXXX)
6. The Corporation qualified as a "small business corporation" as defined in subsection 248(1) of the Act at some time in the XXXXXXXXXX taxation year.
ADDITIONAL FACTS FROM SUBMITTED DOCUMENTS
7. XXXXXXXXXX.
8. The Corporation followed a reorganization plan that provided for it to cease its activities in XXXXXXXXXX services and concentrate its efforts on maintaining and developing its most profitable activities, namely XXXXXXXXXX.
9. According to the documents provided, the Corporation did not cease to carry on its business and the shareholder continued to control the Corporation and to direct its operations following the acceptance of the proposal by the creditors.
YOUR OPINION
10. You are of the view that the comments in opinion E9806237 apply to the current situation so as to deny the BIL claimed by the shareholder.
The shareholder disposed of his debt to his corporation, a person with whom he was not dealing at arm's length at the time of the disposition, and the condition set out in subparagraph 39(1)(c)(ii) of the Act was not satisfied.
All of the conditions described in paragraph 6 of Interpretation Bulletin IT-239R2 were not satisfied; more specifically, the Corporation has not permanently ceased carrying on its business. Consequently, the taxpayer's capital loss is deemed to be nil by virtue of subparagraph 40(2)(g)(ii) of the Act.
11. For the purposes of subdivision c of the Act - Taxable Capital Gains and Allowable Capital Losses, the expression "disposition of property" is defined in section 54 and includes: “any transaction or event by which ... any debt owing to a taxpayer or any other right of a taxpayer to receive an amount is settled or cancelled.” Subsection 178(2) of the Bankruptcy Act, which applies to proposals in light of section 66 of that Act, provides that "an order of discharge releases the bankrupt from all other claims provable in bankruptcy.” In the current case, following the payment of the XXXXXXXXXX dividends, the Corporation was discharged from its ordinary creditors and the latter could no longer come back against it to claim the unpaid balances. It therefore appears to us that the shareholder's claim was settled or cancelled as a result of the application of the provisions of the Bankruptcy Act and that he has thus disposed of his claim.
12. To qualify as a BIL, an amount must first be a capital loss. If the capital loss is deemed to be nil by virtue of the application of subparagraph 40(2)(g)(ii) of the Act, no BIL results. A loss from the disposition of a debt or other right to receive an amount is nil under that subparagraph unless the debt or right was acquired for the purpose of gaining or producing income from a business or property.
13. The Agency has stated an exception in paragraph 6 of Interpretation Bulletin IT-239R2 in cases where a shareholder has loaned money at less than a reasonable rate of interest to a Canadian corporation or one of its subsidiaries. Provided that the conditions listed in such paragraph are satisfied, the loss resulting from the loan will not be considered nil. One of the conditions is that the corporation has ceased permanently to carry on its business. In the case under review, the proposal was accepted by the creditors and the Corporation continued to carry on its business in accordance with a reorganization plan that was implemented.
14. Our position as expressed in the Bulletin was called into question by the comments made by the Federal Court of Appeal in Edwin J. Byram (99 DTC 5117):
"[16] The language of section 40 is clear. The issue is not the use of the debt, but rather the purpose for which it was acquired. While subparagraph 40(2)(g)(ii) requires a linkage between the taxpayer (i.e. the lender) and the income, there is no need for the income to flow directly to the taxpayer from the loan.
[17] Such an approach is also consistent with commercial reality. Frequently, shareholders make such loans on an interest-free basis anticipating dividends to flow from the activities financed by the loan...
[18] The ultimate purpose of a parent company or a significant shareholder providing a loan to a corporation is, without question, to facilitate the performance of that corporation thereby increasing the potential dividends issued by the company...
[19] There is a growing body of jurisprudence that considers current corporate reality as being sufficient to demonstrate that the expectation of dividend income justifies a capital loss deduction under subparagraph 40(2)(g)(ii). As articulated above, this approach is consistent with current corporate realities and the purpose of subparagraph 40(2)(g)(ii)."
15. As stated in Income Tax Technical News No. 18 of June 16, 2000, we have accepted the reasoning in this decision. This position is effective for all future assessments and reassessments. The revision of IT-239R2 is being considered to reflect this fact; however, this revision has been deferred pending comments by the Supreme Court Justices in the John R. Singleton case. Taking into account the comments made by the justices of the Federal Court of Appeal, it seems to us that we can accept that the non-interest-bearing advances made by the shareholder to the Corporation were for the purpose of earning income from property. Consequently, the loss resulting from the disposition of his debt qualified as a capital loss for the purposes of the Act.
16. According to the wording of paragraph 39(1)(c) of the Act, a BIL may be incurred only if there has been a disposition to which subsection 50(1) of the Act applies or to a person with whom the taxpayer was dealing at arm's length.
17. For paragraph 50(1)(a) of the Act to apply, the taxpayer must establish that a debt owing to it at the end of a taxation year has become a bad debt. In this case, we have assumed that the proposal was accepted by the creditors on or before XXXXXXXXXX, the Corporation's fiscal period end. Under the proposal, the creditors therefore agreed to the payment of XXXXXXXXXX amounts equivalent to XXXXXXXXXX% of the amount of their claim depending on the availability of funds. As stated in paragraph 11 above, it appears to us that the claim was settled or cancelled and consequently no claim was due to the shareholder and other ordinary creditors at the end of the taxation year.
An argument could be made that a fraction of the debt is uncollectible at the end of the previous taxation year even though another fraction of the same debt is recoverable. However, as stated in question 6 of the Roundtable held at the 1994 conference of the Association de planification fiscale et financière, it does not appear to us that the wording of subsection 50(1) allows a fraction of a debt to be considered an uncollectible debt. Furthermore, we are of the view that subsection 248(27) does not apply for the purposes of paragraph 50(1)(a).
18. As stated in paragraph 16 above, a BIL may result from the disposition of a property to a person with whom the taxpayer was dealing at arm's length. In this case, there is nothing in the attached documentation to show that the shareholder or any other ordinary creditor disposed of their claim to an arm's length person. Although we are of the view that a disposition of the claim occurred for the purposes of section 54, it was not a disposition to anyone. Therefore, in our view, the provisions of subparagraph 39(1)(c)(ii) did not apply.
Please note that as part of the proposal under clause XXXXXXXXXX any "XXXXXXXXXX" undertook, subject to certain conditions, to sign in favour of the trustee a full and complete assignment, waiver or transfer of its rights. The ordinary creditors and the shareholder were not covered by this clause.
19. The Corporation's representatives argued that once the process of submitting a proposal was underway, the trustee coordinated the Corporation's affairs and the shareholder did not really control the Corporation at that time. Consequently, the shareholder disposed of his claim to a person with whom he was dealing at arm's length. To support these points, reference was made to two cases, G Allen et al of the Tax Court of Canada (May 15, 2000) and Duha Printers (Western) of the Supreme Court (98 DTC 6334).
20. We disagree. Nothing in the proposal allows us to conclude that the trustee replaced the shareholder and became, for the purposes of subsection 251(2), the person who controlled the Corporation. The relationship between the trustee and the Corporation appears to us to have been contractual only and not part of an instrument constituting the Corporation. As stated in paragraph 7, the trustee had oversight of the Corporation's affairs and exercised this oversight by referring, among other things, to the financial information available to the Corporation, its accounting records and discussions with management. In the case of a proposal, it appears to us that the trustee does not take possession or ownership of, or seize, the assets. In addition, the shareholder was related to the Corporation pursuant to subparagraph 251(2)(b)(i) by virtue of the control it had over XXXXXXXXXX% of the common shares, and they are deemed not to deal with each other at arm's length pursuant to paragraph 251(1)(a) of the Act.
21. Subsection 251(2) refers to de jure control. In Duha Printers, the Supreme Court stated in its "Summary of principles and conclusion as to control” that in determining "effective control" of a corporation, one must consider: the corporation’s governing statute; the share register of the corporation; and any specific or unique limitation on either the majority shareholder’s power to control the election of the board or the board’s power to manage the business and affairs of the company. Such specific limitations must be manifested in either the constating documents of the corporation (including its articles and by-laws); or any unanimous shareholder agreement. The Supreme Court stated that: "Documents other than the share register, the constating documents, and any unanimous shareholder agreement are not generally to be considered for this purpose."
22. In conclusion, we are of the view that the shareholder can claim a capital loss following the disposition of his debt but that he cannot claim a BIL.
For your information, a copy of this memorandum will be severed using the Access to Information Act and will be available in the Legislative Access Database (LAD) located on the mainframe of the Canada Customs and Revenue Agency. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the Legislative Access Bank version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Should you require any additional information concerning this document, please do not hesitate to contact us.
Ghislaine Landry
Manager
Individuals, Business and
Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
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