Business investment losses are a subset of capital losses, but with special income tax treatment that allows for a faster recovery of the resulting tax savings. Both individual taxpayers and corporations may realize a business investment loss, which can arise from the actual or deemed disposition of certain capital properties.
A business investment loss can arise from a disposition to an arm’s-length person of the shares of a small business corporation or debt owed by the small business corporation. There are circumstances where a business investment loss may arise upon the payment of a guarantee provided on behalf of a small business corporation. As well, owning shares or debt in a small business corporation that becomes bankrupt may result in a business investment loss. Any time a loss arises in respect of shares or debt related to a small business corporation, it is important to assess the circumstances to evaluate whether the actual or deemed disposition may fall within the parameters of special tax treatment for this unique type of loss.
A small business corporation is defined as a Canadian-controlled private corporation, where all or substantially all of the fair market value of the assets were, at that time, used principally in an active business carried on primarily in Canada. The assets of a company would include all those listed on the balance sheet and others that might not be listed such as goodwill. For the purpose of the business investment loss rules, the company must meet the definition of a small business corporation at the time of disposition or at any time within the preceding 12-month period.
Similar to capital losses, a business investment loss is multiplied by the capital gains inclusion rate to calculate the allowable business investment loss. However, while allowable capital losses are deductible only against taxable capital gains, an allowable business investment loss can be deducted against any type of income. This means that the tax shield resulting from an allowable business investment loss can be realized immediately provided that the taxpayer has sufficient other income.
A portion of the business investment loss may be disallowed to the extent the taxpayer has already benefited from the capital gains exemption at any time. The portion disallowed would be considered a capital loss and would still be available as a deduction against capital gains.
An allowable business investment loss is deductible in the current year against any type of income, or it can be carried back and claimed in any of the prior three taxation years, or carried forward and claimed in any of the next 10 taxation years. To the extent the business investment loss cannot be claimed in any of these years, the character of the loss changes to a net capital loss which can be carried forward indefinitely and can be claimed only against capital gains in future years. The rules for carrying an amount forward or backward have changed over the years, depending on when the loss arose. When an amount is claimed as an allowable business investment loss, it will impact the amount of capital gains deduction that can be claimed in the current or future years.
While no one makes an investment with the intention of losing value, sometimes it happens. To the extent an investment is in a small business corporation, the Income Tax Act may allow some leniency in claiming a loss, ultimately resulting in more favourable tax treatment than a regular capital loss.
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.