Subsection 39(1)(c) defines the business investment loss. It may arise from the disposition of:
I. a share of a corporation that is a small business corporation, or
II. a debt owing to the taxpayer by a Canadian-controlled private corporation. If a taxpayer is a corporation, the debtor corporation must be unrelated.
The Canadian-controlled private corporation referred above must be:
I. a small business corporation;
II. a bankrupt corporation that was a small business corporation when it last became a bankrupt; or
III. a corporation that was insolvent and was a small business corporation at the time of a winding-up order.
To be a business investment loss, the disposition must be to an arm’s length person or be deemed to have occurred under subsection 50(1). Subsection 50(1) can be used where a taxpayer:
I. is owed a debt that is established in the year to be a bad debt, or
II. owns shares of a corporation that becomes bankrupt or insolvent.
Subsection 50(1) will deem a disposition of the debt or shares for nil proceeds and to have reacquired the shares or debt immediately after the end of the year for nil cost, allowing the taxpayer to recognize a capital loss even though there was no actual disposition of the shares or debt. The advantage of this is that the taxpayer can write off the investment while still retaining ownership. A taxpayer must elect for 50(1) to apply. To make this election, a letter should be sent to the tax center explaining the loss and requesting it to be considered a business investment loss. It is recommended to attach this chart to the letter.
As per subsection 38(c), an allowable business investment loss (ABIL) is 1/2 of the taxpayer’s business investment loss discussed above. The ABIL can be used to reduce all sources of income. It should be first deducted in the year it arises. Any remaining portion can be carried back 3 years and carried forward 10 years (7 years for ABIL arising in 2003 or earlier years) as a non-capital loss. After 10 years (7 years for ABIL arising in 2003 or earlier years) the unapplied part becomes a net capital loss and will be carried forward indefinitely to be deducted against taxable capital gains
The ABIL is claimed on line 217 of the personal income tax return after completing Schedule 3 indicating a deemed disposal. If the loss is incurred by a corporation, schedule 6 of the T2 tax return needs to be completed.
The business investment loss will be reduced by the amount of any applicable reductions discussed below. The reductions will remain a capital loss.
I. the amount of the taxable dividends paid or payable after 1971 to the taxpayer or the spouse or a trust of which the taxpayer or the spouse is a beneficiary.
II. Twice the amount of capital gain deductions claimed in the prior years (the ratio might be 3/2 or 4/3 if the deductions were claimed prior to 1990).
You should note that the CRA often does a desk audit of an ABIL claimed and requests all of the supporting documentation to substantiate the amount of the ABIL. Be prepared to provide all supporting documents if you claim an ABIL.