It was Shakespeare who wrote, in Hamlet, "Neither a borrower nor a lender be; For loan oft loses both itself and friend, and borrowing dulls the edge of husbandry." Any time the words "dull" and "husband" are used in the same sentence, my wife, Carolyn, will sit up and take notice – as though there's a cure for such a problem. Shakespeare, however, was writing about the folly of lending money to friends.
Let's face it: Loans like this happen all the time. How many friends have helped out others who have had great business ideas, only to see those ideas fail? I'm not going to suggest that you avoid making these types of investments, but make sure you structure them properly so you'll at least get some tax relief if things sour. A decision of the Tax Court of Canada from April 21 tells the story of one individual who could have done things differently and would have saved thousands in tax if he had done so.
Osborne Barnwell and Nicholas Austin had met in the early 1980s, were both from the island of St. Vincent and were living in Canada when they met. They developed a relationship over the years. When they first met, Mr. Austin had been operating a business called Carib-Can, which published children's books.
Mr. Austin was well known in the local West Indian community, and was successful and passionate about his work. Any well-meaning, reasonable business person and friend might see fit to lend money to Mr. Austin for the purpose of starting what seemed like a good idea: a magazine targeting passengers on commercial airlines.
Between 2007 and 2009, Mr. Barnwell lent about $73,000 to Mr. Austin for the new venture. The I's were dotted and the T's were crossed in that the advances were evidenced by promissory notes. Although Mr. Austin had established a corporation to carry on the business, the loans from Mr. Barnwell were made directly to Mr. Austin.
By 2009, things were not going well for the new business. It became clear that Mr. Barnwell would likely not receive repayment of the loans he made. In 2011, Mr. Barnwell claimed an "allowable business investment loss" (ABIL) on his tax return for the debt that went bad.
The Tax Court of Canada (Osborne G. Barnwell v. The Queen, 2015 TCC 98) disallowed his ABIL claim, which cost him about $17,000 in lost tax dollars. A simple change to the loan could have put those dollars back in his pocket.
So, here's the deal: Our tax law will allow an investor in many cases to claim an ABIL if he or she has suffered a loss by lending money to, or investing in the shares of, a small business. An ABIL is different from your typical capital loss. A capital loss can generally be applied only against capital gains. An ABIL, on the other hand, is given more favourable treatment and can be applied against any source of income.
What is an ABIL exactly? Simply put, an ABIL equals one half of money you might have lost by lending money to, or investing in the shares of, a small business corporation that has gone bankrupt or has become insolvent.
It's important that, if you make a loan or invest in shares, the loan be made to or the shares be that of a "small business corporation" under our tax law (which includes most small companies that are Canadian-controlled private corporations where substantially all of the assets of the company are used in a business carried on primarily in Canada), rather than lending money to an individual. This was Mr. Barnwell's problem. He lent the funds directly to Mr. Austin rather than to the corporation carrying on the business.
Similarly, Mr. Barnwell could have invested in the shares of Mr. Austin's company, rather than extending a loan, and if it had been a small business corporation there could have been tax relief in the form of an ABIL.
There are a couple of other points worth noting here: First, virtually all ABIL claims are reviewed by the taxman. So, expect a letter from the Canada Revenue Agency if you make a claim. It's not a big deal as long as you've dotted your I's and crossed your T's, so be sure to get tax advice before you make a claim. Finally, if you've used up any of your lifetime capital gains exemption in the past, all or a portion of your ABIL may be denied and converted to a capital loss instead.
Tim Cestnick is managing director of Advanced Wealth Planning, Scotiabank Global Wealth Management, and founder of WaterStreet Family Offices.