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Claiming Capital Losses

Subject: Losses Number: 09-23 Date: 10/30/2009

It may be advisable for the lender to charge a reasonable rate of interest

When someone suffers a loss on a loan to an individual or a corporation, they may assume that the loss will be deductible for income tax purposes.

Generally, a loss on a loan is deductible, as either a capital loss or a business investment loss, only if the loan was made to earn income. The same principles apply to payments made to honour a loan guarantee. For the payment to create a deductible loss, there must be a guarantee fee.

The Canada Revenue Agency has an administrative position of allowing losses on low or non-interest bearing loans (or on payments of guarantees for which no guarantee fee was received), where the creditor or guarantor is a shareholder. This position does not apply where the creditor is only related to the shareholder. For example, if a parent makes an interest-free loan to a child’s business, a loss on the loan would not usually be deductible by the parent.

In these types of situations, it may be advisable for the lender to charge a reasonable rate of interest on the loan (or a reasonable fee in the case of a guarantee) to preserve the lender’s ability to claim a tax deduction in the event that a loss is suffered.

Interest accrued on the anniversary date of the loan must be reported for tax purposes each year, even if the interest is not received. However, a bad debt deduction can be claimed if the interest is uncollectable. The interest income and the bad debt expense should both be reported on the taxpayer’s income tax return. Similarly, where a guarantee fee is charged, a bad debt deduction may be claimed if the guarantee fee becomes uncollectable.

It may be worthwhile to file T1 adjustment requests if the income and expense have not been reported for prior years those years.

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