Allowable Business Investment Loss (ABIL)
If you lost money investing or loaning money to a Small Business Corporation (including your own business), you may be able to recover some of that loss in the form of a tax refund. Canadian tax laws are purposefully designed to reduce the risk of loss of investments or loans to small business corporations. This type of loss is called an Allowable Business Investment Loss (ABIL), which is a special type of capital loss.
What is an ABIL?
As mentioned above, an ABIL (Allowable Business Investment Loss) is a special type of allowable capital loss that is subject to preferential tax treatment. The special rule relating to an Allowable Business Investment Loss is that, unlike an ordinary allowable capital loss, it is deductible against all sources of income and not just taxable capital gains. Generally speaking, other allowable capital losses can be deducted only against taxable capital gains.
An Allowable Business Investment Loss is a claim (deduction from income) on your personal tax return that allows an investor or lender in a Canadian Controlled Private Corporation (CCPC) to claim 50% of a “business investment loss.”
If a CCPC is essentially insolvent, not carrying on business, or is expected to close down, then the taxpayer can be deemed to have suffered a loss, i.e. unrecovered investment or loan if elections are filed. A taxpayer’s business investment loss is a capital loss from the disposition of:
- shares of a corporation that is an SBC; or
- debt owing
to the taxpayer by a Canadian-controlled private corporation (CCPC)
- an SBC;
- a bankrupt that was an SBC when it last became a bankrupt; or
- a corporation referred to in section 6 of the Winding-up and Restructuring Act that was insolvent within the meaning of that Act and was an SBC at the time of its winding-up order under that Act,
For a loss to qualify as a business investment loss, the disposition must be:
- to an arm’s-length person; or
- deemed to have occurred under subsection 50(1).
Where the debt is owing to a taxpayer that is a corporation, the taxpayer and the CCPC must deal at arm’s length. For these purposes, a CCPC is generally a Canadian private corporation that is not controlled by non-residents or public corporations or a combination thereof. Thus, for example, a private Canadian corporation controlled by Canadian individuals will normally qualify as a CCPC.
In general terms, a small business corporation is a CCPC, all or substantially all of the fair market value of the assets of which is attributable to assets used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it, or debt or shares in other small business corporations.
The CRA takes the view that “all or substantially all” normally means 90% or more. Although these criteria can be met at the time of the disposition of the shares or debt of the corporation, the corporation can qualify as a small business corporation if it meets the criteria at any time in the 12 months preceding the disposition of the shares or debt.
Disposition of debt by a non-arm’s-length corporation
In determining a corporation’s business investment loss in a tax year, subparagraph 39(1)(c)(iv) excludes any capital loss from a disposition of a debt owing to the corporation by a CCPC with whom the corporation does not deal at arm’s length. Therefore, any capital loss resulting from a disposition by a corporation of a debt owing to the corporation by a CCPC with whom it does not deal at arm’s length cannot qualify as a business investment loss.
For a loss to qualify as a business investment loss, it must first be a capital loss. Therefore, when a transaction does not give rise to a capital loss, or when a capital loss is deemed to be nil, no business investment loss can result. For example, a capital loss deemed to be nil by paragraph 40(2)(g) cannot give rise to a business investment loss. A loss that qualifies as an ABIL must be treated as an ABIL. The taxpayer cannot choose to treat it as a capital loss instead.
Carrying unused ABIL to other tax years
Generally, any ABIL that cannot be deducted in the year it arises is treated as a non-capital loss as defined in subsection 111(8). Such a loss can be carried back up to three years and forward up to ten years and deducted in calculating the taxable income of such other years.
A non-capital loss arising from an ABIL occurring in a tax year that ended after 1982 and before March 23, 2004 can be carried back up to 3 years or forward up to seven years and deducted in calculating the taxable income of such other years.
Generally, an ABIL that is not deducted as a non-capital loss by the end of the carry forward period becomes a net capital loss at the end of the tenth year. After the tenth year forward, the ABIL leaves the pool of non-capital losses and rejoins the pool of net capital losses which can be deducted only against taxable capital gains in any year from that point on. This treatment allows the loss to be carried forward indefinitely to be deducted against taxable capital gains beginning in the eleventh year.
Use of an Allowable Business Investment Loss
As noted, an ABIL can be used to offset all sources of income in a year and not just taxable capital gains. Essentially, it is treated as a non-capital loss rather than a net capital loss. Also, it must be applied against all income for the current year to bring income to zero, even if no tax would otherwise be payable.
How is an Allowable Business Investment Loss applied?
Half of the actual losses (including certain personal costs forced on shareholders such as paying for GST/HST or payroll deductions and guarantees) are deductible against all other incomes in certain applicable tax years, as mentioned above.
Insufficient documentation, if you do not make an effort to get the money back, loans to a family member’s company (you need to prove there was a business purpose in mind), will encourage CRA to deny a claim. In other words, where proper documentation is in place and qualifying factors are met, a successful result is more likely.
If you are not a shareholder and did not charge interest on the loan (not necessarily receive it), it will be difficult to prove that you had intention to earn income from the loan. The loss claim could be denied for this reason. However, if you are a shareholder, loans to the company do not have to bear interest because your expectation of income is from dividends.
Chart 6 in Chapter 5 of Guide T4037 can be used to compute an ABIL. See chart below (attached).
Common situations where claim for an ABIL may be successful
- If you bought shares in or loaned money to a CCPC (Canadian Controlled Private Corporation) and the corporation became insolvent and did not pay you back or you sold the shares for less than what you paid for them.
- You invested directly in another person’s small business corporation (either as a shareholder, lender, partner, or joint venture participant) that failed outright or probably cannot repay the investment or loan in full when it becomes due.
- You own or co-own a company (corporation) that is struggling financially or has become inactive and there is a low probability of ever recovering personal funds of yours or others who have invested or loaned funds to it. An inactive company can potentially be eligible for a claim of an ABIL because it has become insolvent; it is not necessary for it to enter in official bankruptcy or dissolution proceedings.
- You were the victim of a scam or fraudulent business activity involving either real or phony business activities of a corporation resident in Canada. The business must have been active for one year.
- You guaranteed a loan to a small business and were compelled to pay the company creditors personally. It has been settled by case law that it is helpful, but not necessary, to charge a guarantee fee to maintain eligibility for such a loss. Chares A. Brown v. The Queen, FCTD, No T-2712-91(96 DTC 6091); Byram v. The Queen, 95 DTC 5069. Subsection 39(12) of the Act deems amounts owing by the corporation to the taxpayer honouring the guarantee to be debt owing to the taxpayer by a small business corporation.
- You invested in an investment club and the club lost investments related to a Canadian Corporation.
- Your corporation is in the business of trading in speculative securities in large volumes. In Robert G. Crompton and Lenora Crompton v. The Queen, 96 DTC 1703, it was found that “the fact the gains and losses had been reported on capital account was not sufficient to justify the conclusion that its transactions were on capital account or that there was no active business. E Ltd., was therefore, a small business corporation…and the taxpayer was entitled to the allowable business investment loss”.
- You were personally assessed by CRA for the company’s withholding taxes (payroll taxes, GST/HST) you paid, and your company was unable to pay you back for its tax obligations.
Terms and Definitions regarding ABIL
All or substantially all, principally, and primarily
For income tax purposes, the term all or substantially all is understood to mean at least 90%, and the terms principally and primarily to mean more than 50%.
Arm’s length and non-arm’s-length
Generally, the terms, arm’s lengthand non-arm’s-length are used in reference to a relationship or transactions between persons.
The term bankrupt is defined in subsection 248(1) as having the meaning assigned by the Bankruptcy and Insolvency Act.
Canadian-controlled private corporation
The term Canadian-controlled private corporation is defined in subsection 248(1) as having the meaning assigned by subsection 125(7).
Small business corporation
The term small business corporation is defined in subsection 248(1). In general, an SBC at any particular time is a CCPC all or substantially all of the fair market value of the assets of which at that time is attributable to:
- assets that are used principally in an active business carried on primarily in Canada by it or by a corporation related to it;
- shares or debts of connected SBCs; or
- a combination of (a) and (b).
For the purpose of determining a business investment loss, a corporation that was an SBC at any time in the 12 months before the disposition of the share or debt will be considered to be an SBC.
A business investment loss results from the actual or deemed disposition of certain capital properties. It can happen when you dispose of one of the following to a person you deal with at arm's length:
- a share of a small business corporation
- a debt owed to you by a small business corporation
- Your loss was an investment or loan (shares or debt) to a private Canadian Corporation i.e. not listed on any publicly traded market;
- The private Canadian Corporation must be majority owned by Canadian residents;
- The business conducted by the small business corporation must be from a location in Canada and must be ‘active income’ (real estate rentals or portfolio investment firm is not active income). Holding companies may be eligible in certain circumstances; and
- Unless you are a shareholder in the company that you loaned funds to, interest has to be charged (not necessarily paid) on the loan.
If you lose money on an investment in a small corporation, you can use an allowable business investment loss to offset your income and reduce your tax bill. This is just one of the ways you can optimize capital losses you experience as a business owner or investor. Make sure you keep accurate records of your investments by tracking expenses and income.
You can deduct your ABIL from your other sources of income for the year. If your ABIL is more than your other sources of income for the year, include the difference as part of your non-capital loss for 2019.
You can carry a non-capital loss arising in 2003 or prior years, back 3 years and forward 7 years. You can carry a non-capital loss arising in a tax year ending after March 22, 2004 through December 31, 2005, back 3 years and forward 10 years.
Although you can generally carry a non-capital loss arising in tax years ending after 2005, back 3 years and forward 20 years, this extension does not apply to a non-capital loss resulting from an ABIL.
A non-capital loss resulting from an ABIL that has not been used within 10 tax years will become a net capital loss in the eleventh year.
To carry a non-capital loss back to 2016, 2017, or 2018, complete Form T1A, Request for Loss Carry-back, and include it with your 2019 Income Tax and Benefit Return (or send it to the CRA separately). Do not file an amended return for the year to which you want to apply the loss.
Complete Chart 6 in Chapter 5 of Guide T4037 to compute the amount of an ABIL. The chart (and a link) is provided in the main body of the article.
It is best to use a tax lawyer in these cases. Tax lawyers are trained to review the precise language of a tax act, policy, or publication to provide their opinion. We are also well adept in dealing with the Canada revenue Agency in such matters. Contact us today to see if your qualifies as an Allowable Business Investment Loss.
-Baber Rahim, JD Candidate and Tax Law Clerk
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