Loss carryovers are an important tool that taxpayers can utilize to reduce their taxable income. When taxpayer incurs a loss, they can use the loss to offset income that would otherwise be taxable. The timing and nature of the loss will affect if and how the taxpayer can utilize the deduction, so it is vital to be aware of these rules in order to utilize loss carryovers to their full potential.
Non-capital losses versus capital losses
A net non-capital loss, meaning a business loss, occurs in a given taxation year when a taxpayer's current year's expenses exceed the taxpayer's current year's income. The Canadian Income Tax Act paragraph 111(1)(a) allows for these losses to be carried forward 20 years and back 3 years to offset the taxpayer's taxable income in that timeframe. A taxpayer is not entitled to deduct a greater amount than one's taxable income in the current year, meaning one will report nil income for that year and use the additional loss to deduct against income in the other years as described above.
A net capital loss occurs when a taxpayer's net capital loss exceeds the taxpayer's net taxable capital gain for a given taxation year. Capital gains and losses arise when a taxpayer disposes of a capital asset at a different price than the purchase price. Paragraph 111(1)(b) allows for these losses to offset capital gains in the three preceding taxation years, and in any subsequent taxation year. These capital losses can only be used to offset capital gains and not other income, generally. An exception to this rule is found in subsection 111(2), which permits the net capital loss for the year in which a taxpayer died and of net capital losses that were unabsorbed in previous years to be deducted as non-capital losses in the year of death and in the immediately preceding taxation year. Another exception is allowable business investment losses (ABIL). These losses may be deducted as non-capital losses and may be carried over subject to the same non-capital loss carryover rules if not fully deducted in the year incurred.
Paragraphs 111(1)(c) and 111(1)(d) define the carryover rules for restricted farm losses and farm losses respectively, while subsection 111(8) sets out the guidelines for the computation of farm loss. These types of losses will not be the focus of this article, but taxpayers should be aware of these categories of losses and consult an expert Canadian tax lawyer in Toronto if they are unsure of how to categorize their loss.
What can be claimed as a non-capital loss?
The Supreme Court of Canada in Stewart v The Queen,  3 CTC 439, 2002 DTC 6969 (SCC) sets out the test for determining whether losses from a venture can be classified as business losses, thus being deductible from taxable income. The test has two parts:
- Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?
- If it is not a personal endeavour, is the source of the income a business or property?
For the activity to be undertaken in the pursuit of profit, the taxpayer must have the intention to profit by looking to the determining factors listed in Moldowan v MNR 77 DTC 5213. Factors are determined on an objective basis, and include:
- The profit and loss in years past.
- The taxpayer's training.
- The taxpayer's intended course of action.
- The capability of the venture to show a profit.
This list is non-exhaustive, and the factors will differ with the nature and extent of each business undertaking. If the venture has elements suggesting it could be considered a hobby or personal pursuit, but the venture is undertaken in a sufficiently commercial manner, it could be considered a source of income if the predominant intention is to make profit from the activity and the activity has been carried out in accordance with the objective standards of businesslike behavior. Courts will not second guess the business judgment of the taxpayer, so whether or not profit was actually realized was irrelevant, the consideration turns on whether the intention was to profit.
The analysis described above is highly fact specific. One should always consult with an expert Canadian tax lawyer if they are unsure whether their venture will qualify for non-capital loss deductions.
Pro Tax Tip: Capital losses must settle by year-end to qualify for deductibility in that year
For a capital loss to be eligible for deduction in a taxation year, the trade must "settle" by the end of the taxation year. For most North American equity trades, there is a trade date plus 2 business days (T + 2) settlement delay from the sell order until the trade is considered "settled". This means that if the stock exchange is closed on the days leading up to year-end, the sell order must be initiated further in advance to meet the trade date plus 2 business days settlement delay window and be deductible in that year. If you have accrued losses on assets, such as crypto, consider crystallizing the losses by selling the asset prior to year end. To determine if the loss is on capital or income accounts consider having a memo drafted by an experienced Canadian crypto tax lawyer.
What is Tax Loss Harvesting?
Tax loss harvesting is a strategy that investors use to offset their capital gains by purposefully selling other assets at a loss. This lets them offset capital gains accrued elsewhere by selling an investment that has an unrealized loss. Unrealized losses cannot be deducted and the asset must be sold before the loss is allowed.
What are allowable business investment losses?
Allowable business investment losses (ABIL) are losses that arise at the sale or other disposition of a share to an arm's length party of:
- a small business corporation (SBC), or
- a debt owing to a taxpayer by a Canadian-controlled private corporation (CCPC) that is either:
- an SBC,
- a bankrupt that was an SBC when it became bankrupt, or
- a corporation referred to in section 6 of the Winding-up and Restructuring Act (WURA) that was insolvent within the meaning of WURA and was an SBC at the time of its winding-up order under WURA.
What losses cannot be deducted?
Some losses are unable to be claimed for tax purposes. One example is superficial losses, which occur when capital properties are disposed of at a loss and an identical capital property is repurchased within 30 days prior or following the disposition by the taxpayer, their spouse, or certain other persons affiliated with the taxpayer and the taxpayer or their affiliates still own or have the right to buy the capital property 30 days after the sale. The definition of affiliated persons is provided in subsection 251.1(1) of the Canadian Income Tax Act. Additionally, losses on transfers of shares to an RRSP, TFSA, DPSP or RDSP are not deductible. There are exceptions to the superficial loss rule, including the possibility of claiming a loss when the disposal of shares is a result of the expiry of an option. You can refer to the CRA's webpage on non-superficial losses for more information. If you are unsure if a loss will be deductible it is always advisable to consult with one of our top Canadian tax lawyers who will be able to advise you on the best course of action.
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.