Jan 19, 2022
As we advised in Tax Tip 20-04 , significant additional disclosure and filing requirements for trusts were announced in the 2018 Federal Budget and are scheduled to apply for trust’s 2021 and subsequent tax years.
“What is required to determine when a debt is uncollectible?.”
Claiming an allowable business investment loss (“ABIL”) is an area that the CRA reviews very carefully. ABIL’s are capital losses that can be treated as non-capital losses and applied against all sources of income. The loss can be claimed pursuant to subsection 50(1) if a loan is uncollectible.
The CRA often takes the position that the debtor must do a number of things to try and collect the debt before he/she is able to claim the ABIL. The case of Netolitzky (2006 TCC 172) deals with these issues. The taxpayer had lent over $7M to his wife’s decorating business. The CRA disallowed the ABIL on the basis that the taxpayer could have done more to collect the debt and to turn the business around, and that he should have obtained independent advice on the value of the inventory and of the business itself. The CRA also took the position that, because of the spouse’s involvement, the taxpayer’s decision was influenced by personal, rather than purely business, considerations.
In making the determination as to whether the loan was collectible, the taxpayer consulted one of his professional associates who agreed with the taxpayer that there was no realistic chance of him being repaid his loans. The CRA felt that a taxpayer should have received an independent assessment of the amount of the loss and the company’s potential resale value. The Judge was very clear that this was “an unwarranted expansion of the duty imposed on the taxpayer” under paragraph 50(1)(a) of the Income Tax Act. The Judge quoted from a previous case that it is “the creditor personally” who must consider the facts leading to a bad debt determination and not an outside advisor.
As to the CRA’s contention that the taxpayer should have done more to collect the debt, the Tax Court Judge quoted a Federal Court of Appeal case that said it was not “necessary for a creditor to exert all possible recourses of collection. All that is required is an honest and reasonable assessment.” In that same case, the Judge made it clear that “there is no obligation on the taxpayer to try and think of every conceivable proactive step and show that none will be productive. It is sufficient that the taxpayer provides evidence as to the condition of the debtor and its ability of the relevant time to repay the loan in whole or in part.”
The CRA’s last argument that the taxpayer had been overly influenced by his wife’s involvement of the business, the Judge stated that a non-arm’s length relationship alone cannot lead to a finding that the creditor did not honestly and reasonably determine the debt to be bad. It was clear in this case that the financial situation of the corporation would not allow the company to repay any of the debt and therefore the loan was a bad debt and eligible for an ABIL.
This is another case that makes it clear that the CRA sometimes interprets the law in a way inconsistent with that of the courts. A careful review of the court’s decisions is important in determining whether the CRA’s basis for its decisions is consistent with the courts. The taxpayer must make an objective decision as to whether the loan is collectible. As well, the taxpayer does not have to complete every conceivable step to collect the funds.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.
TAX TIP is provided as a free service to clients and friends of Cadesky Tax.
The material provided in Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Cadesky Tax cannot accept any liability for the tax consequences that may result from acting based on the contents hereof.