Introduction – Limit on Losses from Shares Held as Capital Property
Subsection 112(3) of the Income Tax Act is a stop-loss rule that limits losses from the disposition of shares held as capital property. This provision applies when a taxpayer disposes of a share that has paid a dividend at a loss.
The rule applies to individuals and corporations and ensures that a taxpayer can't benefit from tax-free or taxable dividends and a full capital loss deduction on the same investment. A limit on these losses stops individuals and corporations from being able to lower their taxable capital gains for a year.
Loss on Share that is Capital Property for Individuals
The loss from these shares for individuals is either the lesser of non-taxable dividends received or the realized loss reduced by the taxable dividends received.
Example: Andrew bought a share of Andrewco for $20, received a $15 capital dividend and a $2 taxable dividend, but also had a loss of $10 from selling the share. Andrew would have a capital loss of $10 without subsection 112(3). However, Andrew had a loss of the lesser of the capital dividend received ($15) or the loss incurred less the amount of any taxable dividends received ($8), leading to a limited loss of $8 and not $10.
Loss on Share that is Capital Property for Corporations
Corporations must subtract from the loss any taxable dividends received, any non-taxable dividends received, and any life insurance capital dividends received.
Example: Anyco purchased a share of Buyco for $20, and Buyco paid a taxable dividend of $5 and a capital dividend of $2. These amounts will be subtracted from any loss Anyco will have of Bco. If Anyco has a $10 loss on the share, then the $7 from the received dividends will reduce Anyco's loss, resulting in a $3 loss instead of $10.
Excluded Dividends from 112(3)
Subsection 112(3.01) can exclude certain dividends from limiting losses, allowing full access to the realized loss. The taxpayer must show that when the dividend was received, the taxpayer and persons not at arm's length did not own more than 5% of a specific class of shares in the corporation and that the taxpayer held the share for the 365 days leading up to the disposition.
For individuals, excluded dividends apply to non-taxable dividends that meet the criteria. Corporations can benefit from all dividends being excluded if they meet the criteria. An experienced Canadian tax lawyer can help you or your corporation plan around this rule, allowing you to fully maximize your capital losses and lower your tax liability on current or future capital gains.
Exceptions to 112(3)
The application of subsection 112(3) is subject to subsections 112(5.5) and 112(5.6), which can render s.112(3) inapplicable or restrict its application.
Under subsection 112(5.5), subsection 112(3) does not apply if the disposition was done after October 1994, the shares were mark-to-market property in the year, and the taxpayer is a financial institution in the year.
Subsection 112(5.6) applies to the dispositions that have occurred under section 142.5 or section 142.6, or the share is mark-to-market in the post-Oct 1994 year. S.142.5 only applies to dispositions made by financial institutions, while s.142.6 only applies to dispositions made by a taxpayer who is becoming a financial institution or ceasing to be a financial institution.
Tax Tips – Understanding Your Investments
It is important to fully understand your investments that pay dividends and whether subsection 112(3) applies to limit your losses. Simply owning shares in the same corporations as your family members or not holding the share for long enough could adversely affect you by limiting your losses. It is important to realize that these rules are not applicable to portfolio stock market investments.
An expert Canadian tax lawyer can help you understand and navigate the rules around your investments and protect your investments through effective tax planning.
FAQ
What if the shares were not held as capital property?
Subsections 112(3) and 112(3.01) do not apply. Our tax system requires differentiating between business income (held as business property) and investments (held as capital property) because of the different treatments of incomes and losses. Losses from shares held as business property are not subject to subsection 112(3) because it only applies to losses from shares held as capital property. Instead, losses from shares held as business property are subject to subsection 112(4) and subsection 112(4.01).
Subsection 112(4) is an analogous rule to subsection 112(3), but in the context of shares held as business property. Subsection 112(4) limits business losses on shares by reducing them by the amount received from previously issued dividends on those shares.
Similarly, subsection 112(4.01) is an analogous rule to subsection 112(3.01). Subsection 112(4.01) precludes business losses from being limited if the taxpayer and people not at arm's length own 5% or less of a class of shares and the taxpayer held the shares for the 365 days leading up to the disposition.
Does subsection 112(3) apply to the dispositions of shares held in a partnership or trust?
No. Subsection 112(3) only applies to shares held by individuals (not including trusts) and corporations. Partnerships and trusts are subject to similar rules, but different provisions. Shares held in a partnership are subject to subsection 112(3.1). Shares held in a trust are subject to subsection 112(3.2).
Subsection 112(3.1) limits a taxpayer's loss on shares that pay dividends held by a partnership of which the taxpayer is a member. The loss is restricted differently for individual taxpayers, corporate taxpayers, and trust taxpayers.
Subsection 112(3.2) limits a trust's loss on shares by reducing the loss by any received dividends from those shares.
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.
