Special tax treatment for bankrupt business

Are you part of a small business that is facing insolvency or bankruptcy? Tax breaks may offer some welcome relief at a very difficult time.

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“Dispositions of small business shares or debt may be deductible,” says Chartered Accountant Karen Slezak, Tax Partner, Soberman LLP in Toronto, “When a small business corporation becomes insolvent or goes bankrupt, creditors and investors in the business may suffer significant losses. In many cases, 50 per cent of these losses will qualify for special tax treatment as Allowable Business Investment Losses (ABILs). “Unlike capital losses that can only be deducted against capital gains, ABILs can offset income from any source. Unused portions of an ABIL can be carried back three years, with the balance carried forward for 10 years. After 10 years, any remaining ABIL balance becomes a net capital loss, which carries forward indefinitely to be used against capital gains.” Several requirements must be met for the loss on a small business share or debt to be considered an ABIL. "If there is an arm's length sale of shares or a qualifying debt, the corporation must be a small business corporation. That is a Canadian-controlled private corporation where all or substantially all (interpreted to be 90 per cent) of the fair market value of the assets are used principally (50 per cent or more) in an active business carried on primarily in Canada,” explains Slezak. Obviously, it is difficult to sell worthless shares or debts, so typically a special tax election is filed by the taxpayer with his/her tax return to trigger recognition of the loss. The election deems that the shares or debt were disposed of for nil proceeds and immediately reacquired after the end of the year for nil cost, as long as: In the case of shares, the small business corporation has become bankrupt or insolvent during the year, and neither it, nor a corporation controlled by it, carries on business. In the case of a debt, it can be established that the debt is uncollectible, and the debt was incurred for the purpose of gaining or producing income. Are there any other considerations when claiming an ABIL? “Yes,” says Slezak. “Any previously claimed capital gains deduction may reduce the amount qualifying as an ABIL. Also, there may be adverse tax implications to the corporation that should be considered as a result of the debt-forgiveness rules.” For further information about Allowable Business Investment Losses, contact a Chartered Accountant. Brought to you by the Institute of Chartered Accountants of Ontario