Tax Loss Determinations
When a taxpayer receives an assessment or reassessment where the losses assessed differs from the taxpayer's filing position, the taxpayer can request a loss determination under subsection 152(1.1) of the Income Tax Act. Filing a loss determination allows the taxpayer to dispute the assessed losses and forces the Canada Revenue Agency (the "CRA") to reconsider the losses claimed. The CRA must respond to the loss determination by identifying the type and amount of the loss. As will be explained in further detail below, losses can decrease the amount of tax owing by the taxpayer in both the year claimed and surrounding taxation years. The ability of losses to decrease tax owing depends on the type of the loss. These loss determinations apply to a non-capital loss, net capital loss, restricted farm loss, farm loss or limited partnership loss. Taxpayers looking to take full advantage of their losses and decrease their taxes payable will therefore want to consult with a Canadian tax lawyer to use loss determinations to convince the CRA to accept their filing position.
The Tax Power of Losses
Taxpayers should take full tax advantage of their losses. Each loss can offset income that would otherwise be taxable. This offsetting reduces the amount of tax owed to the CRA not only in the year the loss is incurred but potentially in other years as well. The application of losses to previous and future years is known as loss carryovers. Loss determinations can be made on the following five types of losses:
Non-Capital Losses: These are losses arising from employment, business or property. Since 2006, these losses can be carried forward 20 years and back 3 years. The exception to these carryover periods is allowable business investment losses which if not claimed as non-capital losses in the first 10 years since they were incurred will become ordinary capital losses. These non-capital losses can be used to offset non-capital income.
Net Capital Losses: These losses arise where the capital losses from the sale of capital property exceed any capital gains realized. A 50% inclusion rate is applied to both capital gains and losses. Net capital losses can be carried back three years or forward indefinitely but can only be used to offset capital gains.
Farm Loss: Where a taxpayer engages in the business of farming and farming is a taxpayer's primary source of income, farm losses can be used to offset farming income and other non-capital income. Farming losses incurred after 2005 can be carried forward twenty years and carried back three years.
Restricted Farm Losses: Where farming or farming and another activity are not a taxpayer's primary source of income, the taxpayer's farming losses are divided into two categories. These taxpayers can claim up to $17,500 in farm losses for the year which can be applied against farming income or other non-capital sources of income. The amount of farm losses claimed is calculated as the first $2,500 of net farming losses, plus one half of any net farming losses in excess of $2,500. Any remaining amount of net farming losses for the year becomes "restricted farm losses". These losses can only be used to offset farming income, or if the taxpayer sells the farm, to offset any capital gains from the sale. Restricted farm losses incurred after 2005 can be carried forward twenty years and carried back three years.
Limited Partnership Losses: Partnerships are flow-through entities, meaning that any of the above types of losses incurred by the partnership are reported proportionally by the partners. A limited partner can use these partnership losses to offset income from the same partnership to the extent of the limited partner's at-risk amount. These losses can be carried forward indefinitely but cannot be carried back.
Not reporting a loss in the year it was earned does not prevent a taxpayer from claiming the loss in a future year. Taxpayers rarely have certainty on their income for forthcoming taxation years, especially given how far in the future certain types of losses can be utilized. Losses which may seem useless in the current year because there is no income to be offset could become very useful tools for decreasing future taxes owing.
Tax Tips: Taxpayers Can Use Loss Determinations to Challenge Nil Assessments
The most common use of loss determinations to challenge a nil assessment or reassessment, that being where the taxpayer is assessed as owing no tax for the year. Nil assessments can not be objected to directly. Rather, the taxpayer must file a loss determination than object to the determination within 90 days of its issuance. This workaround is limited to where the nil assessment involves one of the above listed losses which differs from the taxpayer's loss amount claimed on his, her or its return.
A taxpayer may be inclined to avoid challenging what seems like an advantageous assessment, but there can be benefits. The central benefit of this workaround would be ensuring the CRA recognizes the entire amount of the loss claimed to maximize the carryover and thus utility of the losses. Using the loss determination to allow the taxpayer to object where there was a nil determination may prove utile where the taxpayer disagrees other aspects of the assessment or reassessment. For example, a taxpayer may wish to use this workaround to dispute the CRA disagreeing with the categorization of a taxpayer's income or the result of an audit.
A prudent taxpayer will maximize the advantage of having incurred taxable losses as these losses decrease the overall amount of tax owed. Our experienced Canadian tax lawyers can advise you on the timing of how to best capitalize on your losses and aid you in navigating disputes with the CRA to ensure you derive the full benefit of your losses.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.