Canada: The TaxLetter: Federal Budget Roundup - Tax 101

Last Updated: July 2 2019
Article by Samantha Prasad

For those conservative investors out there, the urge to keep your money in cash and cash equivalent instruments is hard to overcome (despite the low interest payable). However, it should be worth noting that sometimes seeking safety in income producing investments and cash may also mean that you have to think about how to offset any resulting tax.

Triggering Capital Gains

If you hold stock that has an accrued gain, but are convinced that it's still safer to trigger a capital gain on the sale of stock and hold the funds in cash, even though there will be tax to pay, then here are some ways that you may be able to shelter or offset that tax:

  • Bad Loans - Included here could be such items as bad mortgage investments or junk bonds (or even a no-good advance to your company, bad loans to a business associate, and so on.).

To obtain a deduction, the loan must generally be interestbearing. So, if you made a loan to a relative on an interest-free basis, for example, the CRA can take the position that the loan was not taken out for income-earning purposes and therefore no loss is available to begin with. An exception to this arises if you are a shareholder of a Canadian corporation and have advanced the money to it on a low or no interest basis. In this case, provided that certain conditions are met, the CRA will give you at least a capital loss on the bad loan.

When is a loan bad? The government's position is that claiming a bad debt loss on a loan is basically an all-or-nothing proposition: the whole of the loan must be uncollectible; or, when a portion of the debt has been "settled", the remainder must be uncollectible. Also, the party line is that either you must have exhausted all legal means of collecting the debt, or the debtor must have become insolvent, with no means of paying the debt.

  • Out-of-business companies. Another overlooked source of tax loss is investments in companies that have gone bankrupt or are now worthless because of insolvency and cessation of business activities. This may often include a company that has been delisted from a stock exchange.

Note: If a bad investment is in a Canadian private company which was devoted to active business, the loss could qualify as an "Allowable Business Investment Loss" (ABIL); if so, this type of loss can be deducted against any type of income, whereas a normal capital loss can only be deducted against capital gains. So ABILs are the "holy grail" of losses. But with that power, comes much responsibility (or so they say). Translation: beware as CRA will generally send you a questionnaire looking for information on the ABIL; be prepared to have your documents in order and ensure you speak with your tax advisor before you claim that ABIL.

  • Bonds purchased at a premium – If you have invested in a bond (outside of your RRSP), it may be the case that you purchased it at a premium over its redemption price because the coupon rate on the bond itself may have been higher than comparable interest rates when you bought the bond - in these cases, there will probably be a capital loss at maturity or if you have sold the bond.
  • "Last chance" capital gains election. This might be a long-shot, but if you have been a long-time investor, it doesn't hurt to check your 1994 return to see if you have made the "last chance" election to take advantage of the now-defunct $100,000 capital gains exemption. For most investments, this will result in an increase in the cost base of the particular investment item. On the off-chance that you have held on to that investment for the last 25 years, and decide that now is finally the time to dump it, then your capital gains tax might be reduced based on the bumped-up cost base (again, this is a long-shot). (If your gain is on a mutual fund and you made the election on it, you may have a special tax account - known as an "exempt capital gains balance" - which can be used to shelter capital gains from the fund.)
  • Check your loss carryforward balances. Another thing you should do is check to see whether you incurred capital losses in a previous year, which you never used. This is quite possible, because deductions for capital losses can only be claimed against capital gains and unclaimed capital losses can be carried forward indefinitely. If you don't have back records, another idea is to contact the CRA to request your personal carryforward balances.
  • Have your kids report Capital Gains. If an investment is owned by your kids, the gain can be reported on their tax return. This could dramatically slash - even eliminate - the tax bite. Here's why: Every Canadian individual – irrespective of age - is legally entitled to the basic personal exemption, which covers off the first $12,069 of income (for 2019). And with the 50 per cent capital gains inclusion rate, this means that kids with no other income can now earn just over $24,000 of capital gains annually, without paying a cent of tax. And even if the gain exceeds this amount, since your kid pays tax on the gain in the lowest tax bracket, the tax rate is only about half of what a high-income earner would pay.
  • Defer with Reserves. If you sold an investment for a capital gain, but you are not entitled to receive the cash proceeds until the end of the year, you are allowed to defer a portion of your capital gain until next year by claiming a "reserve." Basically, reserves may enable you to defer your tax on capital gains over a five-year period, where the full amount of proceeds are payable over time.
  • Check your losers. And, this goes without saying, if you looking to get out of stocks, there's a chance that for every stock that has an accrued gain, you probably have another stock that is sitting in a loss position. So simply engage in tax-loss selling – sell of some of your losers to trigger some losses to offset your gains.

Increasing your Investment Income

In the search for yield, investors have turned to such things as monthly income funds and income trusts, structured notes, capital class units, and so on. But again, cash in your hands means investment income that must be reported on your tax return.

Income splitting has always been a long traditional way to minimize tax on investment income. However, the attribution rules and the tax on split income (TOSI – formerly the kiddie tax) have more than curtailed this. Happily, there are a number of key strategies which can allow you to trump CanRev at its own game.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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