To sell or not to sell…that is the question…on the minds of individuals and business owners holding assets that have fallen in value. Fortunately, appropriate tax planning for losses can minimize tax payable and increase cash flow during a period of economic downturn.
There is a dizzying array of very complex rules sprinkled throughout tax law that allow numerous types of tax losses and at the same time prevent taxpayers from inappropriately creating, buying, or using losses.
We present an abridged version of the common tax losses available for businesses and individual and some of their related restrictions:
Background – Types of Losses
The two most common types of deductible losses are “Capital” and “Non-Capital” losses.
Generally speaking, non-capital losses are ordinary business-type losses. They may be carried back three years to recover income taxes paid previously or carried forward 20 years to reduce income taxes payable in the future. Non-capital losses may be applied against any type of income.
Capital losses arising from the disposition of capital property and may be carried back 3 years and carried forward indefinitely, however, capital losses may only be deducted against capital gains.
“ABIL” – Allowable Business Investment Losses
50% of a loss from a disposition of certain shares or debt owing to the taxpayer by a “small business corporation” may be deducted against any source of income, and can be carried back three years and forward up to ten years. This loss has characteristics of both capital and non-capital losses.
Shares of Insolvent Corporations and Uncollectable Loans
An election is available to trigger a loss on shares of insolvent corporations or certain uncollectable loans. This has the effect of realizing a loss on these properties without formally disposing of them.
Corporate loss consolidation
CRA accepts tax loss planning between related companies – strategies for a profitable company to utilize losses of related companies. These include amalgamations, transfers of income-producing assets to related companies, reasonable intercorporate management fees for services or property, and many others.
Restrictions and Tax Traps
The loss on the sale of capital property to “affiliated persons” are denied, if the same or identical property is repurchased from them within 30 days. An example would be selling securities at a loss and buying the same securities back within 30 days.
A loss on the sale of capital property to a related corporation is suspended until that property is ultimately sold to a non-related person.
Where a company acquires control of a non-related entity with losses, the use of these pre-acquisition losses is very restricted. The purpose of this rule is to prevent “loss-selling” or “monetizing losses” by selling them to non-related entries.
Capital Dividend Restrictions
Careful consideration should be given to the timing of filing the appropriate tax election and the trigging capital losses. Capital losses reduce the amount of tax-free Capital Dividends that a company can pay its shareholders.
Other “Stop-loss” Rules
Other common situations where losses are denied include losses on the sale of personal-use property, losses on property transferred to RRSPs and TFSAs, losses on the transfer of debts to related persons, and losses on disposition of debt for non-income purposes. An example of the latter is interest free-loans, with some exceptions.
At Sloan Partners, we are experts in corporate reorganization and tax advisory. We work directly with business owners as well as small and medium accounting firms to utilize loss-related strategies and achieve the most favourable tax results for small business owners and their families.
Need COVID related tax advice for your business? Contact Roman via email.
Roman Belenky CPA, CGA is a tax specialist with Sloan Partners LLP specializing in tax planning and advisory for business owners and their families.
Disclaimer: This article is intended for educational and informational purposes only. It is not intended in any way whatsoever to provide tax advice. The reader should be aware that legislation and administrative policy are subject to change at any time. None of the persons involved in the preparation of this article accepts any responsibility for its contents or the consequences that arise from its use.