Investment Income, Gains, and Losses
Complex attribution rules prevent spouses from simply splitting joint investment income between them to equalize their tax brackets. Joint investment income includes interest on joint bank accounts, investment income from joint brokerage accounts, rental income from jointly owned real estate, and capital gains from the disposition of jointly owned investments.
The attribution rules require that joint investment income be allocated between spouses based on each individual’s contribution of funds to acquire the investment. Spouses with joint investments should be prepared to support their allocation of investment income by keeping track of the source of the funds used to acquire the joint investments.
There are opportunities to split investment income between spouses while not being subject to the attribution rules discussed above. Contact a Chartered Professional Accountant to help you review your tax planning strategies to potentially take advantage of income splitting with your spouse.
The phrase “capital gains” is one that should be understood thoroughly. In broad terms, “capital gains” are profits realized from the sale of assets that are “capital property”–the difference between the proceeds of sale and the cost of the property. (For income tax purposes, the cost of the property is called the “adjusted cost base,” or ACB.)
What constitutes capital property can be quite complex. For example, if you acquire a property for the purpose of reselling it, the property will generally be considered inventory, not capital property. If, however, you acquire property for the purpose of earning income from it, like a building on which you intend to earn rental, that asset will generally be considered a capital property. For most individuals, investments in bonds, shares, mortgages, and similar investments are capital property, the sale of which will result in a capital gain to the extent proceeds exceed ACB or capital loss to the extent proceed are less than ACB. (There are rules that suspend or deny losses under various circumstances.)
Only 50% of capital gains are taxable (taxable capital gains), and the other 50% is tax exempt.
Generally, if you gift an asset, you will have a deemed disposition of the asset at its fair market value and a capital gain, to the extent its fair market value exceed ACB. Alternatively, you will have a capital loss on the asset to the extent its fair market value is less than ACB. (Again, there are rules that suspend or deny capital losses under various circumstances.) In certain circumstances where a capital gain is realized on property donated to a Canadian registered charity, the entire capital gain can be tax exempt.
Capital gains realized by individuals on a disposition of shares of a “Canadian-controlled private corporation” engaged in an active business that meets the definition of a “qualified small business corporation” can be offset with the individual’s “lifetime capital gains exemption”. The lifetime capital gains exemption limit is currently set at $813,600 (indexed for inflation). For the capital gains on the sale of qualified farming or fishing properties the lifetime capital gains exemption limit is now $1 million.
Given the favourable treatment of capital gains, it might be more tax effective to hold investments that will yield capital gains outside of a RRSP / RRIF and TFSA, and hold other assets (such as interest-bearing securities) inside a RRSP / RRIF and TFSA. Contact a Chartered Professional Accountant to help create tax strategies to take advantage of the lower tax rates for capital gains.
Individuals resident in Canada throughout the year have available to them a “lifetime capital gains exemption” of $813,600 (indexed for inflation) to offset the capital gains realized on the sale of shares of “Canadian controlled private corporations” (CCPC) that are “qualified small businesses corporations” (QSBC) (The $813,600 “lifetime capital gains exemption” equates to a $416,800 lifetime capital gains deduction, remembering that only 50% of a capital gain is taxable, so only 50% of the capital gains exemption is applied to the taxable capital gain). For the gains on the sale of qualified farming or fishing properties the lifetime capital gains exemption limit is now $1 million.
The claim for the lifetime capital gains exemption will be reduced by any previous claim of the capital gains exemption, by the individual’s existing “cumulative net investment loss” (CNIL) balance and by any previous claims of “allowable business investment losses” (ABIL).
If you have a disposition of shares of a QSBC you should consult a Chartered Professional Accountant to see if you have any unused “capital gains exemption limit” and whether your capital gains exemption is limited by a CNIL balance or an ABIL claimed in the past. If you are contemplating the sale of shares of a QSBC you should consult a Chartered Professional Accountant before the sale to ensure the company is a QSBC, to determine your remaining capital gains exemption limit and whether your capital gains exemption is limited by a CNIL balance or an ABIL claimed in the past.
The non-taxable portion of a capital gain realized by a private corporation can be distributed by means of a special dividend referred to as a “capital dividend”. Capital dividends received by a Canadian resident shareholder are fully exempt from tax.
The amount of tax-free capital dividend available for distribution is accumulated in a notional corporate tax account referred to as the “capital dividend account”. The capital dividend account is a running balance that includes the non-taxable portion of capital gains and is reduced by the non-allowable portion of capital losses and prior payments of capital dividends. To ensure that the amount paid out is maximized, pay out capital dividends when capital gains are realized and before any capital losses are realized.
The corporation paying the capital dividend must file an election with the Canada Revenue Agency on or before the earlier of the day the dividend becomes payable, or the day any part of the dividend is paid. This election needs to be accompanied by a certified true copy of the corporate resolution to pay the capital dividend.
Other receipts can also add to a corporation’s capital dividend account such as certain life insurance proceeds and capital dividends received from other corporations. The net non-taxable portion of income inclusions arising from the dispositions of eligible capital property can also be added to a corporation’s capital dividend account but only at the beginning of the year following the year of disposition. If you would like more information about paying a capital dividend, seek the advice of a Chartered Professional Accountant.
There are four types of capital losses:
- Listed personal property losses;
- Personal use property losses;
- Losses on shares or debt of a small business corporation; and
- Losses on other capital properties.
Capital losses from listed personal property (such as artwork, jewellery, stamps, and coins) are only deductible against capital gains on listed personal property.
Losses from the sale of personal use properties (such as a car, boat or home) are generally not deductible.
Losses from the sale of certain small business corporation shares or debt may be considered “allowable business investment losses” (ABIL). An ABIL is a capital loss. Normally a capital loss is only deductible against a capital gain but an ABIL is deductible against other sources of income (albeit at a 50% inclusion rate). The ability to claim an ABIL may be limited by previous years’ capital gains exemption claims. The CRA will audit the claim of an ABIL; you must be able to prove the amount of the investment, the type of investment and provide evidence of the investment loss.
Losses on the sale of other capital properties must first be netted against capital gains realized in the year but may then be carried back three years (use Form T1-A) or forward indefinitely to offset capital gains realized in other years.
Generally, a “superficial loss” can occur when you dispose of capital property for a loss and you, or a person affiliated with you, buys the same or identical property (called “substituted property”) during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale, and you or such affiliated person still owns the substituted property 30 calendar days after the sale. If you have a superficial loss, you cannot deduct it when you calculate your income for the year. However, if you are the person who acquires the substituted property, you can usually add the amount of the superficial loss to the adjusted cost base of the substituted property. This will either decrease your capital gain or increase your capital loss when you sell the substituted property.
Losses triggered on the transfer of assets to an RRSP, RRIF, or TFSA are deemed to be nil.
If you have capital gains in the year or prior three years and unrealized losses on your investments, as you approach year-end you might consider triggering those losses before the year-end to save income taxes on your capital gains or to carry your capital losses back. Be aware that there are “stop-loss” rules designed to negate losses triggered on “superficial” transactions, so contact a Chartered Professional Accountant to help you devise a loss-selling strategy.
If at the end of a year, you own shares of a company that went bankrupt in the year or became an insolvent corporation (as defined in the Bankruptcy Act or the Winding-up Act), you might be able to claim a capital loss on those shares on your income tax return for the year. The capital loss is calculated as a notional disposition of your shares for zero proceeds if you elect to do so in your tax return for the year. To qualify for this election, the corporation must generally be bankrupt or otherwise insolvent and expected to be wound up or dissolved with the fair market value of your shares determined to be nil.
The election to claim the capital loss for shares of a bankrupt company is simply a letter to the CRA filed with your tax return. The letter will advise of the disposition (for zero proceeds) of the shares of a company that filed for bankruptcy in the year and provide details of the investment. If your tax return is e-filed, the election must be mailed to the CRA on or before the filing due date for your tax return (generally April 30 of the following year). Because the failure to file the election could result in the CRA denying the capital loss, you should consider filing the election using registered mail.
Where the loss is on shares of a “Canadian-controlled private corporation” (CCPC) engaged in an active business, under certain circumstances the loss may be an “allowable business investment loss” (ABIL). An ABIL is a capital loss, meaning only 50% of the loss is allowable. Unlike a capital loss that can be deducted only against capital gains, an ABIL can be deducted against other sources of income. The CRA will review all ABIL claims so you need to have evidence of the original investment, proof the company in which you invested was a CCPC engaged in active business, and support there was a loss triggering event in the year.
Contact a Chartered Professional Accountant to see whether you might be able to write off an investment in shares and whether the resulting loss might qualify as an ABIL.