Allowable Business Investment Loss: A Canadian Tax Lawyer Analysis

What is an ABIL?

An allowable business investment loss (ABIL) is a type of capital loss with one special tax treatment. Unlike capital losses that can only be deducted against taxable capital gains, an ABIL is deductible against all sources of income. If there are excess ABILs that are unused in a year, they can be carried back 3 years and carried forward 10 years. For the ABILs that are still unused after 10 years, they will be treated as net capital losses and carried forward to be deductible against taxable capital gains indefinitely.

Business Investment Loss

An ABIL is 50% of a business investment loss, that can be incurred under the following scenarios:

1. Actual disposition

A business investment loss is incurred when there is a capital loss from an actual disposition to an arm’s length person (a party not related to you or doesn’t share a common interest with you) of

• A share of the capital stock of a small business corporation; or
• Debt in a Canadian-controlled private corporate (CCPC) that is:
  • A small business corporation,
  • Bankrupt and that was a small business corporation at the time it became a bankrupt, or
  • A corporation that was insolvent and a small business corporation at the time a winding-up order was made in respect of the corporation.

A CCPC is defined under s.125(7) of the Income Tax Act, it is generally a Canadian private corporation that is not controlled by non-resident or public corporations, or a combination of both.

To qualify as a small busines corporation, at least 90% of the fair market value of the asset of the CCPC must be attributable to:

• Assets principally used in an active business carried on primarily in Canada by the CCPC or a related corporation, or
• Shares or debt obligations of other small business corporations in respect of which the holding corporation owns more than 10% of the shares.

A corporation can qualify as a small business corporation as long as it meets the criteria at any time in the 12 months preceding the disposition of the shares or debt.

A business investment loss can also occur if a taxpayer is required to repay a corporation debt from a previously made guarantee. Under subsection 39(12) of the Income Tax Act, a payment made by a taxpayer under a guarantee of the debts of a corporation is deemed to be a debt owing to the taxpayer by a small business corporation if:

• The payment was made to a person with whom the taxpayer was dealing at arm’s length; and
• The corporation was a small business corporation both at the time the corporation incurred the debt in respect of which the guarantee payment was made and at any time in the 12 months before the time any amount first became payable under the guarantee.

1. Deemed disposition

In addition to actual disposition, a deemed disposition can occur under s.50(1) of the Income Tax Act where a taxpayer is deemed to have disposed of the share or debt at the end of the taxation year for nil proceeds and to have immediately reacquired the property at a cost of nil. Generally speaking, a deemed disposition can occur if you make an election for a year in respect of:

• A debt owing to you at the end of taxation year that is established to be a “bad debt” (it is uncollectable) in the year, or
• A share in a corporation owned at the end of the year, where
  • the corporation has become bankrupt during the year.
  • The corporation is insolvent and a winding-up order has been made in the year or
  • The corporation is insolvent, neither the corporation nor a corporation controlled by it carries on business, the fair market value of the share is nil, and it is reasonable to expect that the corporation will be dissolved or wound up and will not carry on business again.

Pro tax tips – make sure you keep the supporting documents

The Canada Revenue Agency (the “CRA”) tends to audit ABILs regularly and a business investment loss incurred on a bad loan requires an intention to earn income from the loan. Therefore, one way to meet this requirement is to charge an appropriate interest rate on the loan. While shareholders might not need to do this because they may argue that their expectation of income comes from dividends, it is safer to properly document the loan in writing and charge an interest amount. Either way, it is recommended to keep all the supporting documents available. When structuring advances to a corporation, or if you have investment losses and CRA has denied your claim for ABIL, contact our office to speak with an experienced Canadian tax lawyer for guidance.