Investing in small Canadian business could help save on taxes

Uncertainty in the stock market has many active and retired farmers looking for alternatives, and investing in a small business corporation, or SBC, is one option to consider.

To qualify as a SBC for tax purposes, the business must be a Canadian-controlled private corporation and at least 90 percent of its assets must be used in an active business in Canada.

One benefit of investing in a SBC is favourable tax treatment if the investment doesn’t work out. Losses from investment in a SBC may be treated differently than investments held in public company stock.

Typically, when money is lost on an investment like shares in a publicly traded company, it is treated as a capital loss and can be used to reduce past or future capital gains.

Although helpful in allowing investors to reduce the taxes that would otherwise be owed on capital gains, these losses cannot be applied to other sources of income, such as farming income.

Losses realized on investments in SBCs may allow investors to use special tax rules that make these losses deductible against other income sources.

For tax, this type of loss is referred to as an Allowable Business Investment Loss, or ABIL.

Like capital losses, only 50 percent of the loss can be applied, but it can be used to reduce other types of income, including farming and employment income earned during the year.

Depending on the level of income and province, this could mean significant tax savings.

For the loss to be considered an ABIL, one of the following must occur:

  • You must own a share of a SBC that has gone bankrupt, is insolvent or the corporation will be dissolved or wound up and will no longer carry on business.
  • The SBC owes you a debt that will not be collected and is considered a bad debt at the end of the year

Using an ABIL to reduce income levels can have drawbacks. It will reduce the lifetime capital gains exemption limit available in the future.

If the lifetime limit has already been used, the business investment losses are disallowed. The amount that is disallowed is not lost. It is simply converted to an ordinary capital loss.

If investors have loaned money to or bought shares in a SBC that has since ceased operation, they may have an ABIL to claim.

These claims can result in significant tax savings to the taxpayer so the Canada Revenue Agency will usually require supporting documentation to validate the claim.

Contact a professional to help identify whether the losses will qualify as an ABIL and if there are any opportunities available to recover some of the money lost.

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