Subsection 50(1) of the Income Tax Act permits a taxpayer to make an election in their return of income for the year to deem them to have disposed of a debt or share at the end of the year for proceeds equal to nil, and to have reacquired it immediately after the end of the year at a cost equal to nil.
If the election is made on a debt, the debt must be owing to the taxpayer at the end of the taxation year and established to have become a bad debt in the year.
If the election is made on a share, the share must be owned by the taxpayer at the end of the taxation year, and either (i) the corporation became a bankrupt during the year, (ii) a winding-up order was made under the Winding-up Act in the year, or (iii) at the end of the year, the corporation was insolvent, it does not carry on business, the fair market value of the share is nil, and the corporation will be dissolved or wound up and will not commence to carry on business.
The deemed disposition will give rise to a capital loss to the extent of the cost of the debt or share.
If the share is of a small business corporation, or the debt is owing by a Canadian-controlled private corporation that is a small business corporation, the resulting loss from the disposition is a business investment loss. Half of a business investment investment loss, being the allowable business investment loss, is similar to a capital loss, except it can be applied against any type of income. A capital loss may only be applied against capital gains.
If the debt is owing by a corporation that does not deal at arm’s length with the taxpayer, the debt may be a “specified obligation” under subsection 80.01(6) and a “parked obligation” under subsection 80.01(7). The debt forgiveness rules in section 80 may apply to include an amount in the debtor corporation’s income. If the corporation is insolvent, a deduction under section 61.3 may be available to offset the income inclusion from debt forgiveness.