“The type of investor can also impact whether an ABIL is available.”
An Allowable Business Investment Loss (“ABIL”) is a special type of capital loss that can be used against all types of income. There is a complex set of rules that determines whether an ABIL can be claimed. A discussion of the more common rules can be found in Tax Tip 04-29.
The type of investment partly dictates what conditions must be met in order to claim an ABIL. These are also discussed in Tax Tip 04-29.
However, the type of investor can also impact whether an ABIL is available or not. In general, If the investor is an individual, trust or partnership an ABIL can be available for a loan, provided certain conditions are met.
If the investor is a corporation, the ability to claim an ABIL on debt is more restricted than if the investor is an individual, trust or partnership. In particular, an ABIL on debt can only be claimed by a corporation if the loan is to an arm’s-length corporation and all the other requirements for an ABIL are met. Related corporations are, by definition, not at arm’s length. For example, a parent corporation and its wholly-owned subsidiary are related, and thus do not deal with each other at arm’s length. Whether two unrelated corporations deal with each other at arm’s length is a question of fact. A discussion on this issue is beyond the scope of this tax tip. Suffice it to say that not all unrelated corporations are considered to deal at arm’s length with each other.
If two corporations are not at arm’s length, then no ABIL will be available on intercompany debt even if all the other conditions for ABIL status are met. In these situations, a loss on the intercompany debt may be a capital loss, the use of which is much more restricted than an ABIL.
In non-arm’s length intercompany situations, ABIL’s can only be claimed on an investment in shares.
If corporations deal with each other at arm’s length, then the tax implications of how an intercompany investment is made will probably not be a priority when deciding between debt or shares/equity. The decision will likely be based on business preferences. If an intercompany investment is going to be made in a non-arm’s length company, then the tax tail favours an investment in shares. If an intercompany debt already exists, it may be possible to convert the debt to shares so that an ABIL would be available in the future if the shares are sold at a loss or become worthless. However, the debt must be worth its face value before it is converted.
In order to navigate through these tricky rules, it is best to consult your TSG tax advisor.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.
The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.
