The Tax Issue:
I loaned some money to my son’s company and now he can’t pay me back. Is there a tax deduction I can claim?
Unfortunately, I get this question quite frequently after it’s too late – a loan has already been made and gone bad. Often, a loan is made from a parent to a child’s company with no interest charged. Under the rules of the Income Tax Act, any loss on a loan made for no consideration is not deductible for tax purposes. So if you are thinking of helping out a family member, don’t be so generous as to deny yourself a tax deduction of you don’t get paid back. Always check with a professional before making a business loan.
If interest was charged, or if you are also a shareholder of the company to which you loaned the funds, 50% of the loss is considered an allowable capital loss. Such a loss may be claimed only against taxable capital gains. Unused losses can be carried back three years and forward indefinitely.
Under certain circumstances, the allowable capital loss may qualify as an allowable business investment loss, in which case it is deductible against any income for the year. The company would have to meet certain tests in order to establish that it meets the definition of a small business corporation. Essentially, this is a corporation that uses all or substantially all of its assets in an active business carried on in Canada.
Before any loss can be claimed, the debt must be established to be uncollectible. According to the CRA you must have exhausted all legal means of collecting the debt and/or the company is insolvent. The courts have taken a more lenient view and require only that the debt be uncollectible in the eyes of the creditor, without the need to exhaust all legal means of collection. If a debt is established to have gone bad in a year, then you must make an election in your income tax return to establish it as a bad debt and claim whatever loss you are entitled to based on the above criteria.