Little-known tax election could help investors holding worthless shares

When a company goes bankrupt or becomes insolvent, investors left holding the worthless shares can use a little-known election to claim the resulting capital loss on their tax returns.

Investors in this situation usually cannot sell the shares if they’ve been delisted, which means investors can’t trigger a capital loss in the typical sense. However, subsection 50(1) of the Income Tax Act allows a taxpayer to make a deemed disposition of shares from insolvent or bankrupt firms.

This election is due when the taxpayer files their return: April 30 for most individuals and June 15 for those who are self-employed, said Ray Loucks, director of tax with Crowe MacKay LLP in Vancouver.

The Canada Revenue Agency (CRA) has no prescribed form for this election, so the process is more involved than checking a box.

The first step is to determine that the corporation is indeed insolvent or bankrupt, or that there’s a reasonable expectation the corporation will be dissolved, said Bianca Tomenson, senior financial planner and director of financial planning and insurance solutions with Castlemark Wealth Management Inc. in Toronto.

“When you file under that section, you have to submit supporting documents in writing,” she said. “So, you do have to gather the backup.” That could include trade confirmations, financial statements, and official documentation and correspondence from the company.

The taxpayer must also determine the amount of the capital loss they’re claiming and report it on Schedule 3. To do this, they would subtract the current value of the shares, which is zero, from their adjusted cost base (ACB).

In many cases, the taxpayer will be able to calculate their ACB using their transaction histories, Tomenson said. She also warned that a taxpayer who purchased their shares at different prices must calculate their average ACB per unit.

“Typically, the institution you invest with will track the average cost of the shares,” she said. “But if you transfer institutions, sometimes that information can get lost along the way. So, it’s important to make sure you have the supporting documentation and the trade confirmations from the year of purchase.”

All backup information, as well as a letter stating that the taxpayer is electing to apply subsection 50(1) of the Income Tax Act to the affected shares, then goes to the CRA.

The letter and documentation must be mailed, even if the taxpayer files the rest of their return online. In such cases, Tomenson said the CRA usually connects the election to the taxpayer using their address and social insurance number, so that information should appear in the letter.

The CRA will then review the election, potentially getting in touch for more information if needed. The return would need to be adjusted if the CRA disagrees with the taxpayer’s analysis.

“When the election is filed properly … the taxpayer’s shares or debt are deemed to have been disposed of for no proceeds at the end of the year and reacquired by the taxpayer immediately thereafter at a cost equal to nil,” which is the fair market value of the shares, states a Crowe Soberman blog post. (The superficial loss rules don’t apply here.)

With this year’s increase to the capital gains inclusion rate, claiming all available capital losses becomes more important, as doing so may allow a taxpayer to dip under the $250,000 threshold where the rate remains 50%.

Net capital losses may be carried back three years and forward indefinitely. These losses are adjusted to reflect the inclusion rate applicable to the year in which the net capital loss is deducted.

In the unlikely case that the worthless shares later regain value, Tomenson warned that a taxpayer who still owns the shares after making the election and sells them for more than $0 will incur capital gains taxes.

For example, say an investor bought a share for $100, the share became worthless and the investor made the 50(1) election. After the election, the ACB for the share is $0. If the share price later rises to $300 and the investor sells their share, they will owe capital gains tax on a $300 gain, not the $200 gain they would have been taxed on had they not elected to use 50(1).

Clients who didn’t know about the election and missed the filing deadline can still submit.

“This election can be late-filed at the discretion of the CRA, but a penalty of $100 per month late is applicable and must be paid with the filing of the election,” Loucks said. “There’s always the possibility CRA could refuse it, but I haven’t seen that, especially when the taxpayer pays the penalty.”

What about the terminated Emerge ETFs?

Loucks said the 50(1) election could be used by the small proportion of investors who held the delisted and terminated Emerge ETFs in their non-registered accounts and incurred capital losses. As the ETFs have been terminated, they now have a fair market value of nil. (Emerge Canada Inc. itself does not appear in the national bankruptcy or insolvency database as of press time.)

Proceeds of the ETFs were paid out to unitholders toward the end of December 2023. Even if the payout settled in 2024, Loucks said the CRA may view the disposition as taking place in 2023.

“It is a question of fact as to when disposition of the ETF units took place,” Loucks said. He said the Income Tax Act states that disposition occurs “at the time that the unitholders were entitled to proceeds of disposition.”

“From the notice provided by Emerge Canada Inc., the unitholders should be deemed to have disposed of their units when the ETFs were terminated,” he said, “as they had a vested right to the net sale price and there were no conditions precedent to be fulfilled in order for the ETFs’ custodian to make the payments at that time.”

If a unitholder didn’t claim the loss on their 2023 return, Loucks said the late-filing provision would apply, adding that the unitholder would need to weigh the expected benefit of claiming the capital loss against the $100 per month penalty.

Loucks said the 50(1) election could also be used to claim a capital loss associated with the receivable owing to certain Emerge ETF unitholders if the receivable is not repaid and the unitholder decides to write it off as a bad debt.