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Is a Business Loss Tax Deductible in Canada?

Rebecca Rustin
Swimming in shark infested waters

Running your own business is an empowering way to earn income. But what happens if you incur a business loss? Keep reading to find out what you should do if your business expenses ever surpass your business income.

What happens when your business loses money?

Most small business owners lose money at some point. Examples of business losses may include start-up costs, expanding operations, or even a drop in sales due to a recession. Basically, if your expenses exceed your income any given year, you will have a non-capital loss.  Generally, a non-capital loss for a particular year includes any loss incurred from employment, property or a business. You can reduce your taxes by using your non-capital losses to offset income you received from a job, a commercial enterprise, retirement and other sources.

How to apply a non-capital loss to another year?

If you have a non-capital loss arising from a tax year ending after 2005, you can roll it back (i.e., apply it to a prior year's tax return) as far as three years to help recover taxes you paid in a previous year. As long as your capital loss does not result from an Allowable Business Investment Loss (ABIL), you can carry your non-capital loss forward up to 20 years to help reduce future taxes payable. More about ABILs below.  If you had a non-capital loss arising in a tax year ending before March 23, 2004, you can roll it back three years and forward seven years. You can carry a non-capital loss arising in a tax year ending after March 22, 2004, through December 31, 2005,3 years prior and 10 years forward.

When should you roll a non-capital loss back?

If you incurred a non-capital loss this year, you might be wondering whether you should apply it to this year's tax return, carry it forward, or apply it to a prior year's return. Here are some situations when it might be wise to apply your non-capital loss to a previous year:

  • Your tax rate was higher in a previous year than you expect it to be in the future;
  • You don't expect to make a profit in the coming years;
  • You are planning on selling or merging your business in the near future;
  • Rolling this year's non-capital loss back to a previous year will generate some much-needed cash flow.

Keep in mind that if you are planning on rolling a non-capital loss back to a previous year, you will need to do so in the year you incurred the loss. If a loss remains unused in the year when it occurred, you will only be able to carry it forward to a future year.  If you would like to carry a non-capital loss back to any of the three last years, you can fill out Form T1A Request for Loss Carryback. Include it with this year's tax return, or send it separately if you are filing electronically. Filing an amended return for the year the loss is not necessary.

When should you carry a non-capital loss forward?

Deciding whether or not you should carry a non-capital loss forward will require some foresight on your part. If you think your tax rate is likely to increase in the future, it can be a good idea to carry your non-capital loss forward.  If you are expecting to make large profits in the future, carrying a non-capital loss forward may help to reduce your tax burden. In some cases, it can also help reduce your tax rate.

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What is business investment loss?

There is another type of business loss you can incur, and that is a business investment loss. Among other things, you can experience a business investment loss when you dispose of your share of a small business or corporation, or a debt you are owed by a small business corporation.  Typically, a business investment loss should be included in the net capital loss portion of your income tax return. However, if your allowable business investment loss (ABIL) is more than your other income sources for the year, you can include this amount in the non-capital loss section of your income tax return (line 252).  Profits and losses from a business are not the same as profits and losses from investing in a business. In fact, these two things are entirely different in the eyes of the CRA.  If you own your own business, you are required to put time and effort into its operation. Conversely, being an investor in a company usually means making a financial contribution to a company run by someone else. If a business that you have invested in fails, that's a business investment loss.

How to claim a business investment loss?

You can claim business investment losses to offset your capital gains on your income tax return. You might also be able to deduct an investment loss against your income in the following situations:

  • The business you invested in owes you money (other than what they received from the sale of personal-use property) that is considered a bad debt at the end of the year;
  • You own a share of a small business or corporation that has either gone bankrupt during the year or is insolvent at the end of the year;
  • You disposed of your share of a small business or corporation and received nothing of value in return.

For the above to apply, the company must have been operating as a small business or corporation in the last 12 months. If you are having trouble determining the status of your investment based on the criteria set forth above, please consult a CPA or tax professional.

What is the allowable business investment loss (ABIL)?

If you had a business investment loss during the year, you can deduct 1/2 of the loss from income. The 50 percent you can claim is considered an allowable business investment loss (ABIL). If this portion of the loss is greater than your total income, you can carry the remaining amount back to a previous year.  If you are not able to apply your net capital losses to a previous year, you may also be able to carry them forward. But, you must utilize such capital losses to earlier years before you can apply them to a later year.  In situations where you were not able to deduct your ABIL as a non-capital loss within the timeframe permitted, the portion that has yet to be applied will be considered a net capital loss. You can use this net capital loss to reduce your taxable gains in a future year.  If you decide to use a net capital loss from a prior year to this year's capital gain, your taxable income lowers for the current year. The reduction will not affect your net income.  You should be able to view any losses you have yet to apply on your notice of assessment. If you are not sure whether there are potential losses that you can claim, you can always contact the CRA.

How to report your capital gains and losses

To calculate your capital gains or losses, use Schedule 3 of the CRA's general income tax and benefit package. If the amount you enter on line 199 of Schedule 3 is negative, you have a capital loss.  If this is the case, do not claim the amount on line 127 of your tax return. The CRA will enter this amount into its system and keep track of the loss so that you can claim it in a future year unless you decide to carry the loss back to a prior year.

How many years in a row can your business sustain a loss?

If your firm consistently loses money year after year, you may have to contend with the notion that you are pursuing a hobby rather than a business. The CRA does not set a threshold on the profit level you must achieve for your activities to be considered a business. However, it does use a profit test to gauge whether your activities have a reasonable expectation of being cash positive.  Other than a few limitations on farming and fishing income, there is no limit on the non-capital losses you can accumulate and carry forward to another year. However, the income you earn in a single year determines the maximum allowable amount of the deduction. In other words, you will never be able to create a refund out of a business loss.  According to The Globe and Mail, claiming a business loss too many years in a row could also cause the Canada Revenue Agency to deny your loss claim. The expectation by the CRA is that you should generate income as you cut your losses. Claiming excessive business losses could also put you at risk for an audit.  Rest assured that true business losses are tax deductible. They can be used to reduce your income to as much as zero in extreme circumstances, and carried forward or rolled back to another year as needed. Doing so can be a strategic way to reduce your tax rate if you think you might make significantly bigger profits in future years.

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