Covid-19 and the lockdown measures imposed as a result of the pandemic have caused financial losses for many businesses and capital assets. Consequently, many of your business-owner clients may have experienced a loss last year. An overview and refresher of losses under the Canadian Income Tax Act can help you mitigate the financial losses experienced by companies, individuals and trusts. The scope of this article is limited to discussing losses reported on a Canadian tax return.
Type of loss: Non-capital or net capital
Non-capital losses
When calculating income for a tax year, your client can deduct losses from an office, employment, business or property, as well as allowable business investment losses incurred during the year, against all types of income for the year.[1] Non-capital losses can be fully deducted against all income types for the year the loss was incurred, for any of the 20 years after the loss was incurred, or for any of the three years before the loss was incurred. For example, if your client incurs a non-capital loss of $1,000 in 2020, they can deduct $1,000 from all types of income earned in 2017, 2018, 2019, 2020 or 2021 – 2041.
Net capital losses
Net capital losses can be used only to offset capital gains. A taxpayer has a net capital loss when they sell, or are deemed to have sold, a capital property for less than its adjusted cost base plus the expenses and outlays involved in selling the property. A net capital loss is deductible from any capital gain in the year applied at the set inclusion rate (currently 50%). Net capital losses can be used in the year they were incurred to offset capital gains, carried forward indefinitely or carried back three years. For example, if your client incurs a net capital loss of $1,000 in 2020, they can offset any capital gains earned in 2017, 2018, 2019 or 2020 and beyond by $500.
Distinguishing between a non-capital loss and a net capital loss
Determining whether a loss is a non-capital or net capital loss depends on several factors, such as the nature of the property sold, the length of ownership, the frequency or number of similar transactions by the taxpayer, the work expended on or in connection with the property realized, the circumstances responsible for the sale of the property, and the taxpayer’s motive in acquiring the asset. Put simply, assets held as inventory that are sold, or deemed to have been sold, at a loss will generate non-capital losses, whereas disposing of assets that are acquired as long-term investments or assets that are used primarily to facilitate a taxpayer in carrying on business will generate a net capital loss.
How to apply a non-capital loss or a net capital loss
Applying a non-capital loss or a net capital loss starts with reporting the loss on a tax return. Net capital gains (or losses) are reported on schedule 3 for individual returns, schedule 6 for corporate returns and schedule 1 for trust returns. Non-capital gains (or losses) are reported on a taxpayer’s income tax and benefit return, a corporate income tax return and a trust income tax and information return. In general, if net income for the year is a negative amount, the amount is considered to be a non-capital loss. For individuals, use form T1A for a carryback of a loss from 2020 to any of the three previous tax years. For corporations, use schedule 4 to request the carryback of any losses to prior years. For trusts, use form T3A to request the carryback of a loss from 2020.
Allowable business investment losses
An allowable business investment loss (ABIL) is a unique net capital loss. Unlike regular net capital losses, ABILs are deductible from all sources of income. An ABIL results from the actual or deemed disposition of a share of a small business corporation, or a debt owed to you by a small business corporation. An ABIL may arise when a small business corporation owes you a debt that is considered bad at the end of the year or when you own a share of a small business corporation that has gone bankrupt or is insolvent. If an ABIL is available, a taxpayer can elect under s. 50 (1) of the Income Tax Act to dispose of the debt or the share at the end of the year for proceeds equal to nil and to reacquire the debt or the share immediately after the end of the year at a cost equal to nil.
[1] Subject to unique rules applicable to losses from a partnership and farming.
Part 2 will address the documentation required to support a loss filing position, and how to dispute a loss determination. Appealing a loss determination is unique because it requires the taxpayer to file supplementary forms, in addition to the standard notice of objection.
Marco Iampieri is a tax lawyer with Iampieri Law Professional Corporation in Innisfil, Ontario, practising tax litigation and tax planning.