compare with interest and dividends

Taxation of capital gains came to Canada in 1972 to replace estate and gift taxes.

What Are Capital Gains?

Capital gains are "profits" realized when a capital property is sold for more than the purchase price.

Sources

Capital gains can arise from

• bonds
• interest in a partnership or trust
• mutual funds
• real estate (other than a principal residence)
• segregated funds
• stocks

Taxation

Capital gains receive more favourable tax treatment than interest and dividends. Only a portion of the gain is taxed.

• personally-owned
  • the marginal tax rate applies to the taxable portion (see below)

Equations

Capital Gain = Proceeds of Disposition, if positive

• declared in the year earned

Capital Loss = Proceeds of Disposition, if negative

• can apply against capital gains
• can carry back 3 years
• can carry forward indefinitely

Net Capital Gains = max{0, Total Capital Gains for the year - Total Realized Capital Losses}

• only realized capital losses can be applied against capital gains

Net Taxable Capital Gain = Taxable Portion of the Capital Gain (e.g., 50%)

• taxed at the owner's marginal tax rates

Taxable Portion

The portion of the capital gains which is taxable (sometimes called the "inclusion rate") has changed over the years.

Corporations
The nontaxable portion of the capital gains goes to the Capital Dividend Account for future tax-free distribution to shareholders.

Capital Gains Exemption (CGE)

An individual (but not a corporation such as a holding company or trust) can realize up to $750,000 of capital gains tax-free from a

• Qualified Small Business Corporation
• Qualified Farm Property

This is an outright exemption, not a deferral of tax. The exemption was $500,000 until March 2007. The exemption is reduced by the earlier $100,000 exemption on other property.

The exemption is often crystallized when an estate freeze is implemented. There are potential complications if

• limits if there is a Cumulative Net Investment Loss (CNIL) since 1987
• Alternate Minimum Tax (AMT): must then include the entrire capital gain (i.e., taxable portion = 100%)

Eligibility

Ownership of holding companies and operating companeis is analyzed on a consolidated basis

Qualified Small Business Corporation

There are three criteria

1. a Canadian-Controlled Private Corporation (CCPC) during the preceding 24 months
   • 50% of shared owned by a Canadian taxpayer or related party (not by publicly-traded corporations)
   • shares held privately (not traded on a public exchange)
2. at least 90% of the Fair Market Value (FMV) of assets used in the active business
   • during the 24 months before the share disposition, at least 50% of the FMV of assets must be used in the active business conducted primarily in Canada
     • inactive business assets: cash and other liquid investments, cash value of corporately-owned life insurance
     • this condition is least likely to be met, but usually solvable
3. carrying on an active business primarily in Canada

Qualified Farm Property

• land in Canada which is used for active farming on a regular and continuous basis by the taxpayer, the taxpayer's spouse or the taxpayer's children
• includes interest in a family farm partnership or corporation

History