A taxpayer that holds shares or debt of a corporation that has no value, may be able to make an election under Subsection 50(1) of the Income Tax Act to trigger a deemed disposition of the shares or debt for $nil proceeds, and trigger a capital loss (or possibly an allowable business investment loss depending upon the facts).
In order to claim a loss on debt, the taxpayer needs to establish that the debt has become uncollectible in the current year.
With respect to shares, the corporation must be bankrupt, being wound up, or insolvent and no longer carrying on business. The shares of the insolvent corporation must have no value and it must be reasonable to conclude that the corporation will be wound up or dissolved.
Documentation to support the presumption of insolvency should be retained to support the filing position. If the liabilities exceed the assets on a fair market basis, the corporation is generally considered to be insolvent.
If the shares or debt regain some value in the future, there will be a capital gain to the extent that any proceeds are received.
The taxpayer must make the election in his or her tax return for the year that the loan is uncollectible or the company is insolvent, in order to have the deemed disposition apply. There is no prescribed form for making the election. The election is usually made by appending a letter to the return. Where an election is not filed on a timely basis, there is a provision to allow the taxpayer to apply for an extension of time to file the election. The Canada Customs and Revenue Agency could challenge the loss if it is claimed in a subsequent year after the loan has become uncollectible or the company becomes insolvent.
Where the corporation qualifies as a small business corporation, then the capital loss could be considered an allowable business investment loss (ABIL). Whereas a capital loss can only be applied against capital gains, the ABIL can be applied against all income.
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