If you file a Canadian income tax return with a loss and receive a nil assessment from the Canada Revenue Agency, your claim of loss is subject to a federal audit under subsection 152(1.1) of the Income Tax Act. To trigger this audit, you must file a request for notice of loss determination.
You would file such a request to reduce the risk that your losses might be recalculated in subsequent years. These recalculations could result in unexpected liabilities and mounds of future paperwork to track different potential financial statements.
Request for a Loss Determination from the CRA
In most cases, taxpayers apply for a determination of losses after receiving a nil assessment. Since the courts have found that nil assessments are not subject to a taxpayer objection or appeal, the request for a loss determination from the CRA acts as a measure of last resort.
Why This Works
Suppose you want to challenge a nil assessment. You can’t object directly, but you can send a loss determination request to the minister in writing – there is no standard form. You may be able to force the CRA to issue a Notice of Determination/Redetermination of Losses, which then qualifies you to file a Notice of Objection.
After your request for loss determination, the CRA must determine two things:
It needs to classify the type of loss incurred. Losses can be categorized as a non-capital loss, net capital loss, restricted farm loss, farm loss, or limited partnership loss. Tax implications are not consistent among across all loss types.
The amount of loss must be verified. This is normally the crux of the issue. If you believe your nil assessment is incorrect or at least needs a degree of certainty around your final loss amount, the audit of your loss is crucial.
Record-Keeping and Impact on Future Financial Statements
The reason loss determination is so confusing is that the CRA is not bound by any given assessment of loss when reassessing for subsequent years. In other words, the income tax loss calculated for one statute-bared year can change for future years. If you or your business have not prepared for an adjustment in your loss, such reassessments may be jarring or financially stressful.
Other times, the losses may not be applied during the present tax year or even over the next several years. In such circumstances, you are responsible for maintaining additional income and tax records until the loss application occurs. Even when you’re eligible to claim the loss down the road, the CRA has the leeway to reassess the loss at the time of filing – this is referred to as “unfettered discretion.”
Treatment of income tax losses is a complicated subject. Before communicating with the CRA or making adjustments to your record and financial statements, consider consulting a tax and/or legal expert for direction.