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NO: IT-185R (Consolidated)

DATE: See Bulletin Revisions section

SUBJECT: INCOME TAX ACT
Losses from Theft, Defalcation or Embezzlement

REFERENCE: Paragraph 18(1)(a) (also subsections 44(2) and 152(4) and subparagraph 54(h)(ii))


Notice -- Bulletins do not have the force of law

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Losses from Theft, Defalcation or Embezzlement

Latest Revisions -- ¶ 6

Contents

Application

This bulletin is a consolidation of the following:

  • IT-185R dated September 11, 1991; and
  • subsequent amendments thereto.

For further particulars, see the "Bulletin Revisions" section near the end of this bulletin.

Summary

This bulletin discusses the income tax treatment of losses of both a capital and non-capital nature resulting from theft, defalcation or embezzlement from a business by strangers, employees, proprietors and others.

Discussion and Interpretation

Loss of Trading Assets

¶ 1. A loss of trading assets, such as inventory or cash, through theft, defalcation or embezzlement is normally deductible in computing income from a business if such losses are an inherent risk of carrying on the business and the loss is reasonably incidental to the normal income-earning activities of the business. (Some factors relevant to "risk" are discussed in the current version of IT-467, Damages, Settlements and Similar Payments.) In all cases, if the cost of an asset or property is expensed on some other basis, that amount may not be deducted a second time if the asset or property is stolen. Only out-of-pocket losses are eligible for deduction; profits lost or foregone as a result of theft, defalcation or embezzlement are not deductible. Some guidelines applicable in specific circumstances follow below. A related topic is discussed in the current version of IT-256, Gains from Theft, Defalcation or Embezzlement.

Thefts by Strangers

¶ 2. Losses through theft, robbery and shoplifting by strangers are an inherent risk for most businesses. Accordingly, losses of trading assets from these causes in circumstances where the loss is reasonably incidental to the income-earning activities of the business are normally deductible in computing income from a business.

Thefts by Employees

¶ 3. Losses of trading assets through theft, defalcation or embezzlement by employees other than senior employees (as described in 5 below) are considered an inherent risk of carrying on most businesses and, as such, generally satisfy the conditions for deductibility set out in ¶ 1 above.

Thefts by Partners, Proprietors and Shareholders

¶ 4. Losses through theft, defalcation or embezzlement by proprietors, partners or significant shareholders of the business are not normally deductible. In most cases, such losses are more properly considered withdrawals of capital or are sustained outside the normal income-earning activities of the business. On the other hand, in the case of Parkland Operations Ltd. v. The Queen, [1991] 1 CTC 23, 90 DTC 6676 (F.C.T.D.), a corporation was permitted to deduct amounts embezzled from its operating line of credit by two signing officers whose personal holding corporations were minority shareholders in the corporation. The court in that case found that the funds were not taken by the individuals in their capacity as shareholders or by exercising any overriding control, but rather while dealing wrongfully with the operating funds in the normal course of the business.

Thefts by Senior Employees

¶ 5. The treatment of losses resulting from theft, defalcation or embezzlement by senior employees and managers depends upon the circumstances of each case: see Cassidy's Ltd. v. MNR, [1989] 2 CTC 2043, 89 DTC 686 (T.C.C.). If, as is frequently the case, such a loss is not reasonably incidental to the normal income-earning activities considerations in determining deductibility in cases involving senior employees include:

(a) the extent of the senior employee's authority and control -- note that if the individual was in a position to act as if he or she were an owner of the business, the loss is unlikely to meet the requirements for deductibility;

(b) how and at what stage in the income-earning process the funds or property were stolen or embezzled -- note that a loss or diversion of profits which have already been earned by the business is generally not a loss which is incidental to the income-earning activities of the business; and

(c) the extent of any shareholdings in the business by the senior employee -- note that an amount which is misappropriated by an individual in his or her capacity as a shareholder is not deductible (see ¶ 4 above).

General

¶ 6. The amount of loss allowable is the net amount after taking into account any insurance recovery or restitution in the year in which the deduction is claimed. This loss also includes the cost to the taxpayer of discharging a liability to a third party (for example, to a customer) created by a theft or defalcation. In cases where the allowable loss is already reflected in the reported income or loss of a business, for instance, where the losses are reflected in overstated expense accounts, the amount of reported income or loss will not have to be adjusted. In any other case, the allowable loss will usually be deductible in computing income of the year in which the loss is discovered. Where the application of this rule would create a hardship (as might be the case when the thefts have forced the taxpayer into bankruptcy), the loss may be deducted, at the taxpayer's request, in the year (or years) in which the event causing the loss took place, provided that year (or years) is not statute-barred under subsection 152(4).

¶ 7. The guidelines in this bulletin do not necessarily apply:

(a) where the amount of the loss is out of proportion to the risks which might reasonably be expected in the taxpayer's business,

(b) where the circumstances of the loss are extraordinary or doubtful, or

(c) where there has been no attempt to obtain restitution.

¶ 8. If a recovery is effected after the end of the year in which a loss has been allowed, whether by restitution from the wrongdoer or through insurance, the amount of recovery is income in the year in which it is received, or the year in which it became receivable, whichever is earlier.

Capital Losses

¶ 9. Where a taxpayer incurs a loss of a capital asset through theft, defalcation or embezzlement, any compensation received for such property represents proceeds of disposition by virtue of subparagraph 54(h)(ii). The date of disposition of the property, as well as the date on which such proceeds become receivable by the taxpayer, must be determined in accordance with subsection 44(2); see the current version of IT-271, Expropriations -- Time and Proceeds of Disposition. However, where no such proceeds are received for property unlawfully taken, a disposition of the property is considered to have occurred on the date on which the loss of the property was discovered.


Bulletin Revisions

Since the issuance of Interpretation Bulletin IT-185R on September 11, 1991, there have been no revisions to ¶s 1-5 or ¶s 7-9.

¶ 6 was revised to clarify our position on the timing of the deduction for an allowable loss created by a theft or defalcation that is already reflected in the reported income or loss of a business (for instance, as a result of a phony invoice scheme). [March 9, 2001]


Notice -- Bulletins do not have the force of law

At the Canada Customs and Revenue Agency (CCRA), we issue income tax interpretation bulletins (ITs) in order to provide technical interpretations and positions regarding certain provisions contained in income tax law. Due to their technical nature, ITs are used primarily by our staff, tax specialists, and other individuals who have an interest in tax matters. For those readers who prefer a less technical explanation of the law, we offer other publications, such as tax guides and pamphlets.

While the comments in a particular paragraph in an IT may relate to provisions of the law in force at the time they were made, such comments are not a substitute for the law. The reader should, therefore, consider such comments in light of the relevant provisions of the law in force for the particular taxation year being considered, taking into account the effect of any relevant amendments to those provisions or relevant court decisions occurring after the date on which the comments were made.

Subject to the above, an interpretation or position contained in an IT generally applies as of the date on which it was published, unless otherwise specified. If there is a subsequent change in that interpretation or position and the change is beneficial to taxpayers, it is usually effective for future assessments and reassessments. If, on the other hand, the change is not favourable to taxpayers, it will normally be effective for the current and subsequent taxation years or for transactions entered into after the date on which the change is published.

If you have any comments regarding matters discussed in an IT, please send them to:

Manager, Technical Publications and Projects Section
Income Tax Rulings Directorate
Policy and Legislation Branch
Canada Customs and Revenue Agency
Ottawa ON K1A 0L5

This electronic version of this document is the official version.

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