Primer on when you can claim ABIL
This article will be the second in a series of articles that discusses the Allowable Business Investment Loss ("ABIL") within the meaning of the Income Tax Act (Canada) ("Act"). In particular, this article will focus on the meaning of bad debt.
In order to claim an ABIL, there are certain conditions that must be met. In particular, an ABIL may be claimed when there is an actual disposition of shares from a small business corporation ("SBC") or debt owed by a Canadian-controlled private corporation ("CCPC") to an arm's length person resulting in a capital loss. An ABIL may also be claimed when a taxpayer elects to trigger a business investment loss pursuant to subsection 50(1) of the Act. One-half of the business investment loss is the taxpayer's ABIL.
There are two situations that may allow for a taxpayer to elect to claim a business investment loss pursuant to subsection 50(1) of the Act:
- a debt owing to a taxpayer by a CCPC at the end of a taxation year is established by the taxpayer to have become bad debt in the taxation year; or
- when the taxpayer owns shares in a bankrupt, insolvent or wound-up SBC at the end of the taxation year.
This article will set out what bad debt is and the conditions that must be met in order to claim an ABIL on a bad debt.
What is bad debt?
The term "bad debt" is not defined in the Act. According to the Canada Revenue Agency ("CRA"), bad debt is a debt that it owed to the taxpayer that remains unpaid after the taxpayer has exhausted all legal means to collect on it. Bad debt can also materialize when the debtor becomes insolvent and has no means of repaying the taxpayer. In other words, the debt must be uncollectible. It is up to the taxpayer to conduct an honest and reasonable assessment of the debts collectability.
Bad debt can only be claimed in the taxation year the debt became bad debt. The time debt turns into bad debt is a question of fact. The Federal Court of Appeal in Rich v R, 2003 FCA 38, at paragraph 13, sets out a non-exhaustive list of factors that should be considered when determining whether a debt has become bad debt:
- history and age of debt;
- financial position of the debtor, its revenues and expenses, whether it is earning income or incurring losses, its cash flow and its assets, liabilities and liquidity;
- changes in total sales as compared with prior years;
- debtor's cash, account receivable and other current assets at the relevant time and as compared with prior years;
- debtor's account payable and other current liabilities at relevant time and as compared with prior years;
- general business conditions in the country, the community of the debtor, and in the debtor's line of business; and
- past experience of the taxpayer with writing off bad debts.
What are the conditions to claiming an ABIL on a debt under subsection 50(1) of the Act?
In order to claim an ABIL on a debt, four conditions must be met:
- the debt owed to the taxpayer must be bad debt;
- the debt must be owing to the taxpayer at the end of the taxation year in which the taxpayer wishes to claim the debt;
- the debt must be previously included in the taxpayer's income; and
- the taxpayer must elect to have subsection 50(1) of the Act apply.
There is no prescribed form for the subsection 50(1) election, it is made in the taxpayer's income tax return for the taxation year in which the debt became a bad debt.
While there is no prescribed form for the subsection 50(1) election, there are many cases where the CRA has denied a taxpayer's ABIL claim as a result of the subsection 50(1) election not properly being filed. The case Dhaliwal v The Queen, 2012 TCC 84 ("Dhaliwal") considered whether a valid election had been made pursuant to subsection 50(1).
Dhaliwal v The Queen
In Dhaliwal, Mr. Dhaliwal (the "Taxpayer") claimed an ABIL in his 2007 tax return after a debt owed to him became uncollectible as a result of the debtor filing for bankruptcy. One of the arguments put forth by the Minister (the "Respondent") was that the Taxpayer did not file a subsection 50(1) election in his 2007 tax return, and thus, he was not able to claim an ABIL.
In this case, the Taxpayer electronically filed his 2007 tax return. In the CRA's electronic tax returns, there are no options to make a specific reference and elect under subsection 50(1). The issue to be decided was whether a subsection 50(1) election requires an express reference to electing.
The Tax Court held that a subsection 50(1) election has been validly made when the taxpayer clearly communicates in their tax return that they want to be allowed an ABIL The Tax Court found in favour of the Taxpayer because the Taxpayer clearly communicated that he wished to claim an ABIL by filling out the CRA's ABIL schedule and specifying his realized loss in his 2007 tax return.
Notwithstanding the Dhaliwal decision, the CRA takes the position that for returns that are filed electronically, all subsection 50(1) elections, including supporting documentation, should be submitted to the CRA in writing, unless otherwise specified (CRA document no. 2012-0454041C6, October 5, 2012).
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.