In most instances, Canada’s tax system taxes net income, this means that expense are deducted from revenues. For employees, deductible expenses are specifically set out in categories with conditions. For business income and property income, any day-to-day operational expense is deductible so long as the expense is incurred “for the purpose of gaining or producing income”, is reasonable, and is not otherwise specifically disallowed. Because expenses are deductible, the system contemplates instances where the expenses are more than the revenue, and losses result. You can carry losses back and forward within limits. This makes losses valuable and important because it helps even out the tax burden over a number of years.
The Income Tax Act singles out certain forms of investment in small businesses for more favourable tax loss treatment. Usually, investments are capital property that give rise, when there is a loss, to a capital loss. Capital losses are only half deductible and then only against taxable capital gains, making their use less valuable. But when you have a Business Investment Loss that meets certain conditions, the loss is treated more favourably. Half of the loss is deductible from any other form of income, whether employment, business, property, or capital gains. This half is called the Allowable Business Investment Loss or ABIL.
Allowable Business Investment Losses can only result where the taxpayer disposes of property to a person he or she deals with at arm’s length. This excludes immediate family and persons who have a common economic interest with the taxpayer. The property is not just any property, but has to be either a share of a small business corporation, or the debt owing by a Canadian-controlled private corporation (CCPC) that is a small business corporation.
So, although an allowable business investment loss is a capital loss, it can be applied against any other source of income. This special treatment, however, is somewhat restricted. Like other losses, a taxpayer can carry back the loss for three years and recover taxes paid in those years if he or she cannot use the loss in the current year. However, unlike non-capital losses that can be carried forward for 20 years and capital losses that can be carried forward indefinitely, allowable business investment losses can only be carried forward for 10 years. If they are not used within 10 years of being incurred, then the loss falls away and is lost forever.
This special tax treatment is a policy decision meant to favour those who invest in Canadian small businesses. However, it can be difficult for people who suffer a loss on the disposition of qualifying shares or debt to qualify for this special treatment by meeting the conditions in the statute. If you think you may or will suffer a loss when disposing of shares of a small business corporation or debt owed by a CCPC, contact a tax professional to ensure you meet the conditions for ABIL treatment where possible.