When is a Debt a “Bad Debt”?

Coveley v Canada, 2014 FCA 281

This was an appeal from the TCC decision 2013 TCC 417, dismissing the taxpayer’s appeal.  The only issue to be decided by the FCA was whether, in the context of a claim for Allowable Business Investment Loss (ABIL) under the ITA (paragraph 40(2)(d)), the debt owing has become a bad debt at the time the claim was made.

The leading case as to whether a debt has become bad is Rich v. Canada, 2003 FCA 38.  The taxpayer claiming that a debt has become bad must show that the determination that the debt had become bad during the taxation year was an honest and reasonable one.  This requires the consideration of a number of factors.  In Rich, the FCA stated:

[13]            I would summarize factors that I think usually should be taken into account in determining whether a debt has become bad as:

1.         the history and age of the debt;

2.         the financial position of the debtor, its revenues and expenses, whether it is earning income or incurring losses, its cash flow and its assets, liabilities and liquidity;

3.         changes in total sales as compared with prior years;

4.         the debtor’s cash, accounts receivable and other current assets at the relevant time and as compared with prior years;

5.         the debtor’s accounts payable and other current liabilities at the relevant time and as compared with prior years;

6.         the general business conditions in the country, the community of the debtor, and in the debtor’s line of business; and

7.         the past experience of the taxpayer with writing off bad debts.

This list is not exhaustive and, in different circumstances, one factor or another may be more important.

In this case there were statements made, after the year in which it was claimed that the debt had become bad, that the year was going to be a good year for the corporation, the taxpayers continued to advance money to the corporation, the corporation continued to buy equipment,  the corporation has great assets, IP, and innovative solutions, and renovations on the company’s premises were made.  These facts do not point to a corporation where a reasonable person would have lost hope that the debt would be repaid.

The FCA stated that it could not find a palpable and overriding error in the TCC decision.

Sas Ansari, BSc BEd PC JD LLM PhD (exp) CPA In-Depth Tax 1, 2 &3

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