Primer on when you can claim ABIL
This article will be the second in a series of articles discussing the allowable business investment loss (“ABIL”) within the meaning of income tax law (Canada) (“Law”). In particular, this article will focus on the meaning of bad debt.
In order to claim an ABIL, certain conditions must be met. In particular, an ABIL may be claimed where there is an actual disposition of small business shares (“CCS”) or a debt owed by a Canadian-controlled private corporation (“CPCC”) 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. Half of the business investment loss is the taxpayer’s ABIL.
Two situations may allow a taxpayer to elect to claim a business investment loss under subsection 50(1) of the Act:
- a debt owing to a taxpayer by a CCPC at the end of a taxation year is determined by the taxpayer to have become bad debt in the tax year; Where
- where the taxpayer owns shares of a bankrupt, insolvent or liquidated SBC at the end of the tax year.
This article will outline what a bad debt is and the conditions that must be met to claim an ABIL on a bad debt.
What is a bad debt?
The term “bad debt” is not defined in the Act. According to the Canada Revenue Agency (“BOW“), a bad debt is a debt owed to the taxpayer that remains unpaid after the taxpayer has exhausted all legal means of collection. A bad debt can also materialize when the debtor becomes insolvent and has no means to reimburse the taxpayer. In other words, the debt must be uncollectible. It is up to the taxpayer to make an honest and reasonable assessment of the collectability of the debts.
Bad debts can only be claimed in the tax year in which the debt became a bad debt. The time that debt turns into bad debt is a matter of fact. The Federal Court of Appeal of Rich versus R, 2003 FCA 38 at paragraph 13 provides a non-exhaustive list of factors to consider in determining whether a debt has become bad debt:
- history and age of the debt;
- the financial condition of the debtor, its income and expenditure, whether it receives income or incurs losses, its cash and its assets, liabilities and liquidities;
- changes in total sales from previous years;
- cash, accounts receivable and other current assets of the debtor at the relevant time and in relation to previous years;
- the debtor’s credit account and other current liabilities at the relevant time and in relation to previous years;
- general business conditions in the obligor’s country, community and obligor’s industry; and
- the taxpayer’s past experience in writing off bad debts.
What are the conditions for 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 a bad debt;
- the debt must be due to the taxpayer at the end of the tax year in which the taxpayer wishes to claim the debt;
- the debt must first be included in the taxpayer’s income; and
- the taxpayer must elect to apply subsection 50(1) of the Act.
There is no prescribed form for the subsection 50(1) election, it is made on the taxpayer’s tax return for the tax year in which the debt became a bad debt.
Although there is no prescribed form for the election under subsection 50(1), there are many cases where the CRA has denied a taxpayer’s ABIL claim because the election under subsection 50(1) was filed incorrectly. The case Dhaliwal against the Queen, 2012 ICC 84 (“Dhaliwal”) considered whether a valid election had been made pursuant to subsection 50(1).
Dhaliwal against the queen
In Dhaliwal, Mr. Dhaliwal (the “Taxpayer”) claimed an ABIL in his 2007 tax return after a debt owed to him became uncollectible following the debtor’s bankruptcy filing. One of the arguments put forward by the Minister (the “Respondent”) was that the taxpayer had not filed a subsection 50(1) election on his 2007 tax return and was therefore unable to claim an ABIL.
In this case, the Taxpayer filed his 2007 tax return electronically. In CRA electronic tax filings, there are no options to make a specific reference and make a subsection 50(1) election. The issue to be decided was whether an election under subsection 50(1) requires an express reference to the election.
The Tax Court has ruled that a valid subsection 50(1) election has been made where the taxpayer clearly indicates on their tax return that they want to be granted an ABIL The Tax Court has held ruled in favor of the taxpayer because the taxpayer made it clear that he wanted to claim an ABIL by completing the CRA ABIL Schedule and detailing his realized loss on his 2007 tax return.
Notwithstanding the Dhaliwal decision, the CRA takes the position that for returns filed electronically, all elections under subsection 50(1), including supporting documentation, must be submitted to the CRA in writing, unless otherwise specified (document 2012-0454041C6, October 5, 2012).