When a taxpayer suffers a capital loss on the disposition of a capital asset, tax relief is available in the form of an offset against capital gains. To utilize this offset, of course, the taxpayer needs a capital gain.
The capital gain may have been realized in the current year from the disposition of another capital asset. If insufficient current year gains are available, the taxpayer may use the loss to reduce a gain realized in the prior three years or may carry the amount forward to a future year. To benefit from the offset of a prior year capital gain the taxpayer will need to file a loss carryback request with the CRA. Any amount not carried back can be carried forward indefinitely and used to reduce a capital gain realized in a futureyear. In the year of the taxpayer’s death, and the preceding year, any capital losses, including amounts carried forward, can be offset against any type of income.
There is, however, an exception to these rules in circumstances when a taxpayer suffers a capital loss on the disposition of shares of a Canadian-controlled private corporation (CCPC) carrying on an active business in Canada, or when a loan is made for the purpose of earning income from business or property in a CCPC that carries on an active business in Canada and the debt becomes uncollectible. In general terms, these types of capital losses are defined as business investment losses (BILs), and are afforded special tax treatment. One-half of a BIL is defined as an allowable business investment loss (ABIL).
An ABIL can be deducted against any type of income, not just taxable capital gains. This means tax relief can be available much sooner than with a regular capital loss. A BIL can arise on an actual disposition of this type of asset or upon an elected deemed disposition.
A BIL can occur upon the disposition to an arm’s-length party of a share or debt of a company that met the definition of a “small business corporation” at the time of disposition, at the time of bankruptcy, or at the time of windup. A BIL would occur if the proceeds of disposition are less than the taxpayer’s adjusted cost base. In making the claim for an ABIL the taxpayer will want to ensure there is sufficient documentation to prove the disposition actually happened and the debt or shares were from a corporation that met the definition of a small business corporation.
A BIL could also occur if the taxpayer makes the appropriate election in his or her tax return for the year. In order to make the election the corporation must meet the definition of a small business corporation at that time, at the time of bankruptcy or at the time of windup, and the debt or share must have no value.
A small business corporation is defined in the Income Tax Act as being a Canadian-controlled private corporation where all or substantially all of the fair market value of the assets were used principally in an active business carried on primarily in Canada.
It is important to note that an ABIL and the capital gains exemption interact in that a claim for one can impact the other. An individual’s claim for an ABIL will be reduced by a prior capital gains deduction claim. The portion of the ABIL reduced by a prior capital gains deduction claim will be converted into an allowable capital loss.
|Allowable Capital Loss||Allowable Business
|Calculation of the amount||One-half of a capital loss||One-half of a capital loss realized on the disposition of debt or shares of a small business corporation|
|Offsetting amounts||Can only claim against taxable capital gains||Can be claimed against any type of income|
|Carry back to prior year tax return||Back three years||Back three years|
|Carry forward to a future tax return||Forward indefinitely||The ABIL can be carried forward 10 years. At year 11 the ABIL reverts to an allowable capital loss, which can be carried forward indefinitely|
The ABIL rules provide an incentive for taxpayers to invest in Canadian private companies through tax relief designed to recognize the potential for investment risk. However, the rules are complex and the discussion here is of a general nature. Taxpayers would be wise to consult a professional when dealing with losses in this area.
No one lends or invests capital expecting a loss. To the extent a loss is realized in respect of a small business corporation, however, special tax relief may be available.
E.O. & E.
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Contributors to this edition:
James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.