ABIL can make risk of investing palpable

L osing money on an investment is never a good thing, but if your small-business corporation, or one you invest in, falls on hard times and you suffer a capital loss on shares or debt, all may not be lost.

Under Canada’s tax rules, you may be able to deduct half of this loss against your other sources of income under a special rule called an “allowable business investment loss,” or ABIL. Capital losses generally cannot be used against ordinary income, only against capital gains, so this tax relief can help make the bitter pill of a failed investment easier to swallow.

For example, if you lent money to a private company that went bankrupt and cannot repay the loan or you acquire shares of a business that later fails, you may be able to claim tax relief. To qualify for the exception, you must have invested in a Canadiancontrolled private corporation whose assets are used principally in an “active business” carried on primarily in Canada (unless it is considered a “specified investment business” or a “personal services business”).

You may still be able to realize an allowable business investment loss on your taxes when you make interestfree loans to your own company to keep it running, and for some unforeseen reason, your company goes bankrupt and your investment can’t be recovered. But before you do that, you’ll have to dispose of the bad debt to an arm’s-length party (alternatively, you can make an election to treat the debt as though it has been disposed of after the debt becomes bad). The timing of when the debt goes bad is also significant, as you or your company must incur the loss within 12 months after the business ceased. It’s also important to establish, through formal documentation, that the debt is uncollectable at the end of your taxation year.

However, the loss rule may not help you if you provided a family loan to help a relative with a business venture, because your loan may not have an income-earning purpose.

Canada’s tax courts have also ruled on what is considered an allowable business investment loss in recent years, highlighting some kinds of lost investments you might not expect would be eligible.

In one case, a taxpayer loaned money to a startup to allow it to make a deposit on a bid for a business endeavour that was forfeited. The court allowed the taxpayer to claim an ABIL for this uncollectible debt — it was enough that the startup company was pursuing ventures.

But what if you have already claimed the capital gains exemption in a prior year? In this case, you must reduce the amount of allowable business investment loss by any capital gains exemption you previously claimed. This reduction is treated as an allowable capital loss, which you can use to offset any taxable capital gains. In addition, if you deduct an allowable business investment loss against other income, you must first realize an equal amount of taxable capital gains in later years before you can use the capital gains exemption again on any eligible capital gains.

As with business losses, unused allowable business investment losses can be carried back to offset income in any of the three previous years, even though you’ve already filed your taxes. They can also be carried forward to offset income in any of the next 10 years. This is useful if you’ve already offset all your income in a year. However, any unused balance that remains after the 10th year is reclassified as an allowable capital loss.

Hopefully, all your investments are successful and you’ll never have to worry about claiming an allowable business investment loss. But if you aren’t, it’s nice to know there’s a financial safety net to soften the risk.