ALLOWABLE BUSINESS INVESTMENT LOSSES
An allowable business investment loss (“ABIL”) is a special form of allowable capital loss (“ACL”), which is half of a capital loss. However, unlike an ACL, which can normally only be deducted against taxable capital gains, an ABIL can be deducted from all sources of income such as income from employment, business, or property.
This year, you have a $60,000 capital gain and thus a $30,000 taxable capital gain, along with $60,000 of employment income. You also have a $50,000 ABIL.
The first $30,000 of the ABIL reduces the taxable capital gain to zero, while the excess $20,000 ABIL reduces your other income to $40,000. As a result, you are left with $40,000 of net income.
If the $50,000 amount has been a regular ACL, it could reduce your taxable capital gain to zero, but you would still be left with $60,000 of employment income and net income. The unused $20,000 of the ACL could not be used this year, although it could be carried back 3 years or forward indefinitely to offset taxable capital gains in those years.
If your ABILS are not fully used in the year, they can be carried forward up to 10 years to offset all other sources of income in those years. If there are any ABILs remaining after that time, they revert to being regular ACLS and can be carried forward indefinitely, but only to offset taxable capital gains, not other sources of income.
So what is an ABIL?
First, it is one-half of a business investment loss. So what is a business investment loss?
A business investment loss is a capital loss that occurs on a disposition of certain types of property in certain circumstances. There are two types of dispositions that can generate a business investment loss.
A business investment loss occurs when you dispose of property to an arm’s length person at a loss, where the property is:
(1) a share of a “small business corporation”, or
(2) a debt owing to you by a Canadian-controlled private corporation (CCPC) that is
(a) a small business corporation,
(b) bankrupt and was a small business corporation at the time it last became a bankrupt, or
(c) a corporation that was insolvent and that was a small business corporation when it was subject to a statutory winding-up order.
In general terms, a CCPC is a Canadian-resident private corporation that is not controlled by non-residents or public corporations. For example, if you are a Canadian resident and you control your private corporation, it will be a CCPC. Control normally means owing more than 50% of the voting shares of the corporation.
A small business corporation must be a CCPC, but it also must meet the following requirements:
“All or substantially all” of the fair market value of the assets of the CCPC must be attributable to any combination of:
(1) assets used principally in an active business carried on primarily in Canada by the CCPC or a related corporation, or
(2) shares or debt in small business corporations that are connected with the CCPC (“connected” generally means that the CCPC owns at least 10% of the shares of the other corporation or corporations).
An arm’s length person includes a person that is not related to you (in income tax terms). For example, a related person will include most of your close family members, a corporation that you control, and a corporation that you control together with your family members.
The Canada Revenue Agency (“CRA”) takes the view that “all or substantially all” means 90% or more.
A business investment loss can also occur on a “deemed disposition” of one of the above properties. A deemed disposition of the property occurs at the end of a taxation year where:
If the property is a debt owed to you by the corporation, the debt became a bad debt during the year. Basically, a bad debt is one that is uncollectible, based on the facts; or
If the property is a share in the corporation,
the corporation became bankrupt during the year,
the corporation was under a winding-up order made in the year, or
at the end of the year, the corporation was insolvent, it did not carry on a business, the fair market value of the share was nil, and it was reasonable to conclude that the corporation would be dissolved or wound up.
In the case of a deemed disposition, you must make an election for the taxation year in your tax return for the year.
ABIL Reduced by Claimed Capital Gains Exemption
The capital gains exemption allows you to earn tax-free capital gains on dispositions of certain types of property, namely qualified small corporation shares, and qualified farm or fishing property.
The lifetime exemption for qualified small corporation shares is $848,252 in 2018, and the amount is indexed annually to inflation. Since capital gains are only one-half taxed, this currently amounts to $424,126 of taxable capital gains. For qualified farm or fishing property, the exemption is $1 million of capital gains, or $500,000 of taxable capital gains.
A special rule in the Income Tax Act provides that your business investment loss in a taxation year is reduced by the amount of the capital gains that you sheltered in previous years under the capital gains exemption, if any.
In 2015, you claimed the capital gains exemption on $40,000 of capital gains, or $20,000 of taxable capital gains. In 2018, you incurred a $70,000 business investment loss.
Your business investment loss will be reduced to $30,000 ($70,000 business investment loss minus $40,000 capital gains exempted in 2015). One-half of that amount, or $15,000, will qualify as an ABIL which can offset any sources of your income in 2018.
The remaining $40,000 of your loss will then be a regular capital loss, and half of that, or $20,000, will be an ACL that can offset only your taxable capital gains.
Conversely, if you claimed an ABIL in a previous year, it can serve to reduce the amount of the capital gains exemption you can claim in the current year.