Don’t assume the Canada Revenue Agency (CRA) will reduce or eliminate your taxes on the basis of a business failure. How much of the loss you can declare on your tax return depends upon the specifics of the business and the nature of its failure. In some instances, like losses from a “hobby” business, the CRA may deny business losses entirely.
Operating vs. Investing in a Business
Profits and losses from running a business may seem identical to profits and losses from investing in a business. However, the two activities receive different tax treatment.
The CRA tax treatment of money lost in a failed business investment can work against you in a way that the failure of a business you operated cannot. John Pinson, a CPA in British Columbia, notes that “The CRA’s distinctions between businesses and investments are not always obvious and require careful study or professional advice. Americans with businesses in Canada should not assume that the CRA’s rules are the same as the U.S. IRS’s rules in this area – they’re not.”
- Simply put, you own a business if it requires your ongoing participation and contribution of knowledge and labor.
- An investment usually requires a single investment or a periodic series of investments in an enterprise you don’t yourself run.
Whether a specific enterprise is a business or an investment sometimes could be a matter of interpretation. Pinson advises clients, “It’s always a good idea to get a ruling from the CRA in this area.” The status of these activities is discussed at greater length in CRA document IT459, “Adventure or Concern in the Nature of Trade.” When the taxpayer and the CRA can’t agree, the determination may be left to the courts.
Qualifying Investment Losses
Investment losses are ordinarily deductible only against offsetting capital gains. However an investment loss may be partially deductible against income if it meets certain criteria:
- The company was a small business corporation at any time during the preceding 12 months;
- The corporation owes you a noncollectable debt at the end of the year;
- You disposed of the debt or share of the small business corporation and have received nothing of value in return;
- The business has gone bankrupt in the current tax year; or the business is insolvent and a “winding-up” order has been made.
In many instances, the status of your investment according to these criteria will be clear; in others, determining its status – and specifically whether the investment qualifies for favourable tax treatment – may require advice from a CPA or other tax professional.
Deduction Qualifications
- If you have a qualifying business investment loss for the tax year you’re reporting, you can deduct 1/2 of the total loss from your income.
- If your investment losses exceed your income for the tax year, you can carry them back for preceding years and forward for 10 years.
At the end of 10 years, however, any remaining losses become capital losses and are deductible only from capital gains. If your investment is not what the CRA deems a qualifying business investment, you can recover your loss only when you have offsetting capital gains. Capital losses that exceed capital gains in the current tax year can be recovered in three preceding years and in any following years.
Possible Disqualifications
There are several instances where the CRA may disqualify your investment loss entirely.
- If the business you invested in is considered a hobby rather than a business by the CRA, you cannot deduct losses from your investment.
- Investments made to related persons are not automatically disqualifying, but may receive additional scrutiny and subsequently be disqualified.
- Claiming investment losses in Ponzi schemes can become complicated if, for example, the duped investor has received investment returns prior to the collapse of the scheme.
References & Resources
- Canada Revenue Agenc: Lines 217 and 228 – What Is a Business Investment Loss?
- John Pinson, CPA; Martinez, California