Tim Cestnick is managing director at WaterStreet Family Wealth Counsel and author of 101 Tax Secrets for Canadians. firstname.lastname@example.org
Last summer, my kids decided they wanted to make some money. My daughter Sarah did this by making earrings and necklaces out of supplies that I bought her at the store. She sold them to friends and family and made $27.50 in the process. What she doesn't really understand yet is that the supplies cost me $34.75. So, I lost money on the deal.
Not to be outdone by his sister, my son Win decided he wanted to make money too. We brainstormed for a bit and then I suggested that he find lost golf balls and sell them for a dollar each. So, Win and I went golfing. We played a round of golf at twilight one day, and we spent half the time looking for golf balls. We found 55 of them. He then sold the balls for about $50. What he forgets is that it cost me $80 for us to golf so he could make $50. "That was easy Dad! When can we go golfing again?" he asked. We then had a discussion about business profits and losses.
What about you? Have you made an investment in a business only to find that you're never going to recover your investment? In light of the economic climate of 2009, there is no shortage of Canadians who are in this boat. The good news? There may be more tax relief on the horizon than you might think. Let me explain.
If you've made an investment in the shares of, or have lent money to, a small privately held company, and the company is now bankrupt or insolvent, you may have what is known under our tax law as a "business investment loss." If this is the case, you may be entitled to claim one-half of that loss on your tax return as an "allowable business investment loss" (ABIL).
You see, an ABIL is different than most capital losses. Capital losses must generally be applied to reduce capital gains, and can't generally be applied to offset other types of income. Not so with an ABIL. An ABIL is a special type of capital loss that can be deducted against any type of income, not just taxable capital gains.
Like any other capital loss, an ABIL can be carried back up to three years, or can be carried forward for use in the future. If you haven't claimed your ABIL within 10 years, it becomes a regular capital loss and can only be applied against capital gains at that point.
So, here's the deal. In order to have an ABIL, you must own capital property that has declined in value (i.e. shares or a loan to a small business corporation). Next you must dispose of those shares or that loan to an arm's-length party. Now, that's going to be tough. After all, who is going to buy those shares or that loan from you at this point given that they are worthless? Don't worry, there's good news. If you can't actually dispose of that property, you can make a special election under subsection 50(1) of our tax law that will treat those shares or that debt as though you've disposed of it.
We're not quite done yet. The property must be a share of a "small business corporation" (SBC) or a debt owing to you by an SBC. An SBC is a Canadian-controlled private corporation in which all, or substantially all, of the assets are used in an active business carried on primarily in Canada. This is a simplified definition - so speak to a tax pro if you think you might have an ABIL.
You should also know that the company you've invested in, or lent money to, must either be bankrupt or insolvent (there's a definition of "insolvent" that I won't go into today).
Be aware that if you do claim an ABIL, you can expect that deduction to be audited. Now, don't panic. It's likely still worth the claim. But make sure of a couple things. First, make sure your documentation is in order. A loan should be documented by a promissory note or loan agreement. Shares owned should have actually been issued and reflected in the minute books of the corporation, among other things. Second, claim the ABIL in the year the company becomes bankrupt or insolvent, and file your tax return on time. The taxman is not obligated to allow an election under subsection 50(1) if it is filed late. Finally, make sure a tax pro helps with your claim.