Can Canadian investors save tax when a stock’s company goes bankrupt?

Where do you own the investment?

If you own the stock in a tax-preferred account, such as a registered retirement savings plan (RRSP) or tax-free savings account (TFSA), you do not get any tax relief. This is one of the risks of losing money in RRSPs and TFSAs.

RRSP withdrawals are taxable at rates that generally range from 20% to 50%. If it makes you feel any better, one way to look at it is that you’ve really only lost 50 to 80 cents on the dollar of the investment, since you would not have been able to spend 100% of the withdrawal anyway.

You do not get back any of the lost RRSP nor any additional TFSA contribution room.

What type of stock was it?

There may be a difference between the tax treatment of a publicly traded stock that trades on a stock exchange and shares of a private company, Jake.

If you own public securities in a taxable, non-registered investment account, and you have a loss, you can claim a capital loss.

If you own shares of a private company, and you have a loss, you may instead be able to claim either a capital loss or an allowable business investment loss (ABIL).

The tax treatment of capital losses and allowable business investment losses is different. Let’s look at what sets them apart.

Capital losses

Capital losses occur when you sell, or when you are deemed to sell, a taxable investment at a loss. This most commonly occurs when you actually sell an investment. But it can also occur when an event triggers a deemed disposition.

If you transfer an investment into a register account, it bears mentioning this deemed disposition will not trigger a tax-deductible capital loss due to the superficial loss rules.

When a stock goes bankrupt, Jake, you can claim a capital loss, even though you might not be able to sell the shares. According to the Canada Revenue Agency (CRA):

In the case of a share in a corporation… the taxpayer must own the share at the end of the tax year and the corporation must:

1. have become bankrupt in the tax year;

1. be a corporation referred to in section 6 of the Winding-up and Restructuring Act that was insolvent within the meaning of that Act and for which a winding-up order under that Act was made in the tax year; or

1. be insolvent at the end of the tax year, and, at that time, it must also be that neither the corporation, nor a corporation it controls, carries on business. In addition, at that time, the share must have a fair market value of nil and it must be reasonable to expect that the corporation will be dissolved or wound-up and will not commence to carry on business.

So, a bankrupt company should qualify, Jake. And to claim the loss, you need to file an election in writing by including a letter with your tax return in the year of the claim that you are making an election under Subsection 50(1) of the Income Tax Act.

Some brokerages will purchase the stock from you for a nominal amount. And they may charge an administration fee, but this can also allow you to claim the loss and receive an official tax slip (a T5008) that shows the disposition. It also means you do not have to look at the worthless security in your account for years to come.

You can claim capital losses to reduce capital gains incurred in the same year. If your losses exceed your gains in a tax year, you can also carry losses back up to three years to offset previous capital gains. And net capital losses can also be carried forward indefinitely to use in the future against capital gains.

Allowable business investment losses (ABILs)

If you own shares of a bankrupt company that was a private company, you may be able to claim an allowable business investment loss (ABIL) instead of a capital loss. The company must be a small business corporation (SBC).

According to the CRA:

This is a Canadian-controlled private corporation in which all or most (90% or more) of the fair market value of its assets:

• are used mainly in an active business carried on primarily in Canada by the corporation or by a related corporation
• are shares or debts of connected corporations that were small business corporations
• are a combination of these two types of assets

If subsection 50(1) of the Income Tax Act applies—basically, if the company is bankrupt or insolvent at the end of the year—you can claim an ABIL on a small business corporation, Jake.

Unlike capital losses, ABILs can be claimed as a deduction against all sources of income. An ABIL allows a 50% deduction for the loss incurred.

If this results in your income being negative for the year, with a larger deduction than your total income, you will end up with a non-capital loss for the year. This loss can be carried back up to three years, or forward up to 10 years, to offset all sources of income. If you cannot use the deduction within 10 years, however unlikely, it will be converted to a capital loss, which can be carried forward to claim against capital gains indefinitely.

Tax relief when a company goes bust

In summary, Jake, you may be able to get some tax relief when a company you own goes bankrupt. It depends first and foremost which account you own the stock in, as a tax-preferred account may not be eligible. Then, it depends on whether the stocks is from a publicly traded or private company. If it’s a private company, it may qualify for an allowable business investment loss, which can be more advantageous than a capital loss.

Read more about taxes:

• What retirees need to know about tax brackets for 2025
• RBC’s discount broker launches international trading—what to know before you invest
• Year-end tax-saving tips for Canadians for 2024
• Should you incorporate your freelance business?

About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.

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