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(Monday, December 28, 2009)An allowable business investment loss, or ABIL, is a type of capital loss that results from the shares or debt of a small business corporation. It is unique, in that it may be used to reduce all sources of income and not just capital gains, as is the case with a regular capital loss.
Capital gains receive preferential tax treatment over ordinary income in that their taxable amount is calculated at the inclusion rate, which is currently at 50% but is adjusted from time to time. So while all of ordinary income is used to compute income tax payable, only 50% of capital gains are taxable. Similarly, 50% of capital losses may be used to reduce capital gains. What is more, unused net capital losses may be carried back 3 years or forward indefinitely to reduce net capital gains of prior or future years.
But while ABIL’s are similar to net capital losses, they are given special tax treatment in order to promote investment in small and medium-sized Canadian businesses. To illustrate, an allowable business investment loss may be used to reduce all taxable amounts to zero, and it may be carried back 3 years or forward 20 years. In addition, ABIL’s may be carried forward indefinitely after 20 years, but only to reduce net capital gains and not other taxable amounts. As well, the loss in the case of an ABIL need not result from an actual sale of the qualifying property, as is the case with a capital loss, but may also be a loss resulting from what is known as a deemed disposition. A deemed disposition occurs if the debt becomes uncollectible or the shares become worthless because the company goes bankrupt or becomes insolvent and ceases to carry on business.
To qualify as a business investment loss, the property you own must be either a debt owed to you or the shares of a small business corporation (SBC). Canada Revenue Agency defines an SBC as a Canadian Controlled Private Corporation that uses all or substantially all of the fair market value of its assets to carry on an active business in Canada.
That means that company assets such as investments, which are not actively used to conduct the business, cannot exceed 10% of total assets.
The business investment loss is the difference between the purchase price and the proceeds of the shares or debt, less 4/3 or 2/1 of any capital gains deduction claimed in prior years. The fraction used is the inverse of the inclusion rate used to calculate the capital gains deduction in the particular year of the gain. In the case of a deemed disposition, the sale price would be considered as zero and a special election must be filed with Canada Revenue Agency. Then the allowable business investment loss is that portion of the business investment loss calculated at the inclusion rate, currently at 50%. When an ABIL is claimed, you cannot use the capital gains deduction in any future taxation years until taxable capital gains equal to the amount of the ABIL have been included in income.
Allowable business investment losses are frequently challenged by Canada Revenue Agency because they receive such special tax treatment. It is very important to ensure that you have all the required documentation, especially if the Small Business Corporation and the taxpayer who is utilizing theABIL are related parties.
For example, if the ABIL was the result of a debt owed to you by the Small Business Corporation (SBC), you must ensure that you have a signed promissory note from the SBC, and that the interest rate stated on the note is at market rate. Furthermore, you must be able to demonstrate that you have taken all reasonable measures to collect the debt.
Nevertheless, an allowable business investment loss and the special tax treatments allowed by Canada Revenue Agency make its use a valuable resource for income tax planning.
