What is a Capital gain tax? Can you claim a capital gain tax exemption? A capital loss Vs. ordinary business loss, which is better? Knowing these topics will help you in planning your Canadian tax on capital gains.
Ordinary business income/loss Vs Capital gain/loss transaction
When you buy goods in the ordinary course of your business with the intention to sell them to your customer, these goods are called “inventory”. Upon realizing the profit/loss of selling inventory to your customer this profit/loss is treated as your business income/loss for tax purposes. However, when you buy a property (for example a machine or building) to use in your business and do not intend to sell it to your customer in the normal course of your business, the property is called “Capital Property”. You may come across a situation when you need to sell your capital property and any gain/loss from the sale of the property is treated as “Capital Gain/Loss” for Canadian tax on capital gains purposes.
Capital gain taxation
You are self-employed and you have the net business income to report. All your net business income is added to your total taxable income. Net business income means gross business income minus deductible expenses. You were also involved in a capital transaction in which you made a net capital gain. Only 50% of your net Capital Gain is added to your total taxable income. You pay income tax on your total taxable income. Since only 50% of capital gains were added to your taxable income hence you pay income tax only on 50% of your capital gain as Canadian tax on capital gains.
You report your capital gain transaction on schedule 3 and net taxable capital gain on line 12700 on your T1 general personal income tax return or schedule 6 on your T2 corporate income tax return. Canadian tax on capital gains is reported and computed based on these schedules.
Capital loss taxation
Let’s look at the other side of the coin. You are self-employed and you have the net business income to report. You were also involved in a capital transaction but in this situation, you made a net capital loss. Now you can not deduct your capital loss from your net business income.
This is applicable in other tax situations such as…
We are all happy when we have to pay tax only on 50% of our capital gain. But it is important to acknowledge that only 50% of your net capital loss is tax-deductible. If only 50% of net capital gain is taxable then only 50% on net capital loss should be tax-deductible. Having said that, when we have gained, we would like to treat it as capital gain and when we have a loss, we would favor to treat it as a business loss but the option to select this choice may not be available under the Canadian tax on capital gains purposes.
Think of a situation where you have a business or employment or both and you are also trading in shares, futures, currencies, and options. Your income or loss from trading shares, futures, currencies, and options can be treated as an ordinary business transaction or as a capital transaction. If you made a gain, we all would like to treat it as a capital transaction or when we are at loss, we all would like to treat it as ordinary business loss. Business loss is 100% tax-deductible and can reduce your business income, employment income, or income from other sources.
There is a very thin line to decide if your trading activity is a business transaction or a capital transaction and that thin line is your intention. However, when it comes to CRA or a Court they may include various other factors to decide.
You may also be aware of washout sale or superficial loss rule under the Canadian tax on capital gains when you trade in securities. This rule generally applies when you buy back identical securities within 30 days.
Capital gain when you sell your house
When you sell your principal residence you may have a capital gain. However, this capital gain is exempt from income tax if you have used this house for your principal residence for all the years (except one year) since you bought or built it. You must report the sale of your house even if it is exempt from tax as your principal residence. We will discuss this tax situation more in detail in our next blog.
Capital Gain – Investment properties
Invest property is usually a property that you buy with an intention to sell. When you sell an investment property with a profit, you may be happy to report a capital gain where only 50% of the profit is taxable. But that may not be always true. In some instances, the profit on the sale is considered business income and 100% of the profit will be taxable. This scenario may apply when you buy the property with an intention to build and sell. This situation may also apply when your buying to assign, i.e. assignment sale.
RKB Accounting has expertise in cross-border taxation and has been providing accounting and taxation services for the last fifteen years in Canada and USA. RKB services include incorporating a business on both sides of the border, bookkeeping, sales tax, payroll, and corporate and personal income tax. RKB’s expertise includes cross-border tax planning, long-term tax planning, helping business start-ups, business structure planning, and resolving complex tax matters. RKB a CPA(Delaware), CA(India), and CIA(USA) has over 25 years of experience in accounting and taxation in dealing with various countries in the world.
Disclaimer: Information in the blog/post/article has been presented for a broad and simple understanding. This is not legal advice. RKB Accounting & Tax Services does not accept any liability for its application in any real situations. You need to contact your accountant or us for further information.