While a capital loss can only be deducted against taxable capital gains, an allowable business investment loss (ABIL) may be deducted against all other ordinary income including capital gains – making an ABIL a very unique and favourable type of loss.
What is considered a business investment loss?
A business investment loss is a specific type of loss that can occur when you sell or dispose of shares of a small business corporation (SBC), or when a debt is owed to you by a SBC. This must be an arm’s length disposition. To be an SBC, a corporation must be a Canadian Controlled Private Corporation (CCPC) that uses all or substantially all of the fair market value of its assets to carry on an active business in Canada. Since the Canada Revenue Agency (CRA) considers “all or substantially all” to mean 90% or more of the value of the business, this means that company assets such as investments or life insurance policies, which are not actively used to conduct the business, cannot exceed 10% of the total fair market value of the assets. Although beyond the scope of this article, a CCPC is a private corporation which is controlled by Canadian residents. A corporation will not qualify as a CCPC of it is controlled directly or indirectly by a public corporation or non-residents, or a combination of the two.
If you own shares in a SBC which is undergoing serious financial difficulties or has gone bankrupt in the year, you may be able to dispose of these shares for nil proceeds. This can include businesses that have become insolvent and are unable to pay their debts, businesses that have a court order against them forcing them into liquidation, or businesses that are insolvent at the end of the year but still continuing to operate. If one of these situations has occurred, you may be able to elect to dispose (i.e. deemed disposition) of the shares or debt for zero proceeds and claim the loss as an ABIL.
Holding on to valueless shares or debt
A taxpayer can elect under section 50(1) of the Income Tax Act to dispose of the SBC shares or debt for nil proceeds and then reacquire the shares or debt immediately after the end of the year for nil cost. This can be done if the SBC has become insolvent and the shares have a nil fair market value, or the debt of the SBC has been established to be a bad debt. A taxpayer could choose to do this because the investment might have value in the future. Therefore, writing off the investment now, while still retaining ownership, could prove to be a prudent business strategy. For example: If the loss is from debt owed to the taxpayer by the corporation, the taxpayer may use the corporation for starting another business in the future. Although the debt could be recovered in this circumstance, a taxpayer must ensure that the recovery of any amount that has previously been deducted as an ABIL must be included as income.
How can a business investment loss be used?
Your ABIL is calculated as 50% of your business investment loss for the year. However, any amount of ABIL that is more than your income for the current year has to be included as part of your non-capital losses for the year. A non-capital loss can be carried forward up to 10 years and carried back for up to 3 years. Furthermore, if the non-capital loss remains unused after 10 years, then it can be treated as a net capital loss and carried forward indefinitely to be deducted against taxable capital gains. If you are able to carry the loss back to prior years, you can adjust your past tax returns and reduce income from those years. Let`s consider the following example:
You own SBC shares that cost $100,000. Due to financial difficulties, the business becomes insolvent and unable to pay its debts. As a result, if you elect to dispose of the shares for nil, you will have a business investment loss of $100,000 ($100,000 – $0 = $100,000). Since your ABIL is calculated as 50% of your business investment loss, your ABIL will be $50,000 ($100,000 x 50% = $50,000). Provided that you otherwise report $50,000 of income in the year, you will be able to deduct the $50,000 ABIL from your income.
A loss may not always qualify as an ABIL. In circumstances where a capital gains deduction has been claimed in prior years the loss must be reduced by any capital gains deduction that has been claimed in previous years. Although beyond the scope of this article, in 2016 a capital gains deduction of up to $824,177 (indexed for inflation) is available to taxpayers who realize a capital gain on the disposition of qualifying SBC shares. In addition, any available capital gains deduction is reduced by any ABILs incurred since 1985, including the current year.
You realize a capital gain of $824,177 on April 15, 2016 on the sale of qualifying SBC shares. However, you had previously claimed an ABIL of $400,000 on January 1, 2010. As a result, you will only be eligible for a capital gains deduction of $424,177 in 2016.
ABILs are frequently challenged by the CRA because they receive such preferential tax treatment. If you are unsure whether a loss that you have sustained qualifies as an ABIL, or would like help to utilize any ABILs that you think you might have available, contact one of our tax lawyers for a consultation.