While no business owner likes to see his or her business generate losses of any kind, a loss could potentially have a silver lining for tax purposes. Let’s explore how to take advantage of your business’s tax losses and perhaps generate some cash tax refunds. There are three types of tax losses — business (or non-capital) losses, capital losses and “allowable business investment” losses. Each type of loss is generated a different way and is treated differently for tax purposes.
Business (Non-Capital) Losses
Generally, “business losses” or operating losses refers to losses which occur when your business expenses exceed business revenues for a particular taxation year. This situation may occur for many reasons, such as when a business is in startup mode or when there is an economic downturn.
Losses from one business may be used to offset income of another (of the same taxable entity) in the same tax year. If there are more losses available than required for the current year, they may be carried forward and used in any of the next 20 tax years or carried back to up to three prior taxation years. By carrying back the losses, you may be able to recover taxes already paid.
However, it isn’t always a sure thing that you should choose to carry your losses back. You may want to consider whether there will be a more significant benefit to carrying the loss forward to a future tax year. For instance, if your corporation paid tax at a rate of 15.5 per cent in a prior tax year and is expecting to pay some tax at 27 per cent in the next taxation year, you would see significant tax savings by carrying forward your 2014 loss instead and using it to reduce income in a year with a higher tax rate. On a loss of $100,000 that could mean up to $11,500 of additional tax savings just by considering the proper timing of the use of the loss instead of automatically carrying it back.
If you do experience losses and can get cash back, it’s a good idea to file your tax return quickly — don’t wait until the six-month filing deadline to file. And don’t forget to consider the effect a loss can have on the business’s requirement to pay instalments. A loss year may result in an instalment holiday for the following year. Keep in mind though, if your subsequent year is taxable, all those taxes will be due at once, which could affect your cash flow planning.
Another common type of loss is a capital losses, which is generally generated when a capital property (say, an investment) is disposed of for less than its tax cost. These losses are not as helpful as non-capital losses in generating tax savings because they can only be applied against capital gains.
So, if you experience a capital loss in 2014, you can only use it to offset capital gains in 2014 or carry it back three years or forward indefinitely against capital gains (i.e. they do not expire).
Strategic use of capital losses is important too. If your business experiences both a capital and a business loss in a tax year but previously reported a capital gain in one of the last three taxation years, it may be more beneficial for you to carry the capital loss back first to offset the capital gain and then use the business loss to offset any remaining income for that tax year.
Allowable Business Investment Loss
An allowable business investment (ABIL) loss is like a hybrid — only half of it is deductible (like a capital loss) but it may be deducted against any source of income (like a business loss), not just capital gains. However, there are some complicated rules to navigate through to determine if a loss qualifies as an ABIL and whether it may be claimed as such.
ABILs are losses that may occur where your small business corporation, or one you invest in, falls on hard times and you suffer a capital loss on shares or debt.
While this situation is not a happy one, there are some advantageous tax rules that can help lessen the pain. The rules are fairly complex and you should see your advisor for help taking advantage of them.
While tax relief on these kinds of losses can be helpful in lessening the pain of an investment that goes bad, hopefully that is a bitter pill you won’t ever have to swallow.