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Published: March 10, 2020

Last Updated: April 10, 2020

Generally speaking, a taxpayer who is required to honour a Guarantee is considered to have acquired a debt at the time that the Guarantee is honoured equal to the amount of payment made pursuant to the Guarantee.

Whether the debt so acquired is a bad debt is a question of fact. If the Guarantee had been given for adequate consideration it will generally be considered to have been given for the purpose of gaining or producing income. Therefore, if the acquisition of a debt in these circumstances gives rise to a bad debt, any loss arising from a payment required by the Guarantor under that Guarantee will be considered to be a deductible capital loss. In certain circumstances, discussed in Interpretation Bulletin 239R2, loan guarantees for inadequate consideration may also give rise to capital losses.

This occurs where:

  • The corporation (or partnership) which benefited from the Guarantee used the borrowed funds to earn income;
  • The corporation could not obtain financing at competitive rates without the Guarantee;
  • The corporation permanently ceased to carry on its business;
  • The loan from the shareholder to the corporation did not result in any undue tax advantage.

Structured Litigation Settlement

Although a capital loss is better than no loss, it is still, in most circumstances, of limited use.

With proper tax planning, in some cases a payment under a Guarantee that would otherwise give rise to a capital loss can give rise to an income deduction. Consider the case of Limited Partners who provided a Guarantee of the debts of a Limited Partnership. When the Limited Partnership failed to meet its obligations the Guarantors were called upon to honour their Guarantees and litigation was commenced against the Guarantors.

If the litigation had been settled on the basis of the Limited Partners honouring their Guarantees by making a payment to the Plaintiff, then the general rules with respect to Guarantees would be applicable, giving rise to a capital loss.

A better way of structuring the settlement, from a tax point of view, would be to have the Partnership itself agree to make the settlement payment thereby incurring a deductible expense. The Limited Partners would fund the Partnership for the amount of the settlement. The Limited Partners thereby increase their at risk amount which would in turn allow the loss incurred by the Partnership in settling the litigation to be allocated to the Partners. In this way, the Limited Partners effectively get a full write-off for their settlement payment rather than a capital loss.

Advance Planning Essential

To achieve this result, the Minutes of Settlement must be structured in the way set out above in order to enable the Limited Partners to claim the loss. It is therefore essential for tax advice to be obtained prior to negotiating the Minutes of Settlement.


"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."

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