The Need for Private Capital Loss Liquidity
A fundamental drawback of Canadian private capital investments is the inability to sell these off-market investments through an active marketplace. Liquidity limitations are the result of regulatory restrictions that prohibit the sale of the investment except in limited cases. For many Canadian investors, this means being unable to sell their private capital investments outside of the holding period lifecycle, which can be years or sometimes decades.
It's a problem that manifests uniquely in failed and non-performing venture, angel and retail private capital securities (all non-reporting issuer investments that aren't traded on an exchange): Investors are restricted from efficiently creating private capital losses for tax purposes.
DropLoss solves this problem by allowing Canadian investors to offer and sell their qualifying private capital investments to us at a pre-determined nominal value. As an accredited investor, we qualify to purchase the investment under NI 45-106 regulation's and also create the transfer agreements for you automatically using our online platform.
Tax Loss Harvesting
If a Canadian investor has a capital loss, they can may usually use it to offset capital gains and reduce the amount of tax payable in a given year. Although capital losses can be carried forward indefinitely (a Loss Carryforward) they can only be carried backwards 3 years (a Loss Carryback). If an investment has no value, then many accountants recommend that their clients consider selling it during years where the investor has substantial unrelated capital gains. This is often the easiest and most expedient way to create the loss and mitigate the tax applicable to unrelated gains. There are restrictions against certain types of loss creation, including the restrictions on creating losses when the sale of an asset is made to an “affiliated” person such as a relative or company controlled by the seller. This can make “self-generated” losses very difficult for investments that aren’t traded on an open market.
Absent the ability to sell the investment, there may be elections available in the Canada Income Tax Act (“ITA”) that allow Canadians to claim a capital loss where the the loss is attributable to shares of a corporation that has become bankrupt or insolvent during the year and it is reasonable to assume it will be dissolved or wound up ( referred to as an "Insolvent Share Loss Election”). But, the Insolvent Share Loss Election can't be applied to trust units or limited partnership units that are commonly used private market investment instruments . This means that without a buyer in place, crystallizing the capital loss from limited partnership units and trust units can be impossible until the investment is dissolved or wound-up by managements.
Time Value Cost of Illiquid Losses
Time is money, and money with time can make even more money. There's an inherent cost to sitting on unrealized losses when an investor is also experiencing times of gain elsewhere. Through the magic of compounding, the opportunistic reinvestment of a tax loss harvest can be substantial. With Loss Carryback limitations in place, it's not always in an investors best interest to let a failed investment decide when the loss becomes official. In many cases, even a nominal future return of capital that is below book cost is worth less than the reinvested benefit of simply taking the loss and moving on to greener pastures.
DropLoss lets Canadian private capital investors retake control loss crystallization at the time that makes the most sense for them.
Shrinking Options and Increasing Costs
The cost of papering agreements for sale in private market investments that comply with applicable securities laws can be high, and this is assuming that loss-harvesting private capital investors are even able to find a qualifying purchaser willing to buy an investment that has no identifiable value. The legal cost of a transfer and sale agreement can cost into the four figures and may not be prepared fast enough for your purposes. Historically, high-net-worth investors would look to their licensed professional advisors to act as the buyer, but tightening regulations around conflicts of interest are making this more and more difficult to do.
DropLoss uses our online system to economically prepare a transfer agreement evidencing your sale of the investment at a pre-determined value; and through our easy-to-use questionnaire we can economically prepare the agreements and send them to you for signature instantaneously.