ALLOWABLE BUSINESS INVESTMENT LOSSES
One-half of a capital loss is an allowable capital loss, which is normally deductible only against taxable capital gains. However, if the capital loss is a "business investment loss", then one-half of it is an "allowable business investment loss" (ABIL) deductible against all sources of income.
A business investment loss includes a capital loss disposition to an arm’s length person of:
1) a share of a "small business corporation", or
2) a debt owed by a Canadian-controlled private corporation (“CCPC”) that is either:
• a small business corporation, or
• bankrupt, or
• an insolvent corporation that qualified as a small business corporation when it was in the process of being wound up.
You can also have a deemed business investment loss in a year if one of the debts mentioned above becomes a bad debt in the year, generally meaning it is reasonable to believe the debt will not be repaid. In this case, you make an election with your tax return for the year.
Lastly, you can have a business investment loss in a year if you own a share of a small business corporation and
1) the corporation became bankrupt in the year, or
2) the corporation is insolvent, and is being wound up under a winding-up order in the year, or
3) at the end of the year,
(a) the corporation is insolvent,
(b) the corporation (and any corporation controlled by it) does not carry on business,
(c) the fair market value of the share is nil, and
(d) it is reasonable to expect that the corporation will be dissolved or wound up and will not later carry on a business.
As with the bad debt above, you must make an election with your tax return for the year, and you will have a deemed disposition of the share for nil proceeds, leading to the capital loss.
For the above purposes, a CCPC is generally a private corporation resident in Canada that is not controlled by non-residents or public corporations.
A "small business corporation" does not actually have to be small. It is defined as a CCPC where “all or substantially all” of its assets (on a fair market value basis) are:
(a) used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it, and / or
(b) shares or debt in another small business corporation, generally if it controls the other small business corporation or owns at least 10% of the shares of the other corporation on a votes and fair market value basis.
ABILs that cannot be used in the year can be carried forward up to ten years to offset all sources of income. If any amount remains after the 10th year, it becomes a regular allowable capital loss, deductible only against taxable capital gains from that point on.
Business investment loss reduced by previous capital gains exemption
Your business loss otherwise determined is reduced to the extent you claimed the capital gains exemption in a previous year. The reduction is based on the capital gains that were exempt, not the taxable capital gains (which are ½ of the capital gains). The current lifetime capital gains exemption covers (as of 2020) up to $883,384 of capital gains from qualified small business corporation shares and qualified farm or fishing property, with an additional $116,616 for qualified farm or fishing property.
For example, say you had a $100,000 capital loss this year, which qualified as a business investment loss. You claimed the capital gains exemption two years ago, in respect of $60,000 of capital gains. Your business investment loss will be reduced to $40,000, half of which will be an ABIL and deductible against all sources of income. One-half of the other $40,000 will be a regular allowable capital loss and deductible only against taxable capital gains.