BU352 Lecture Notes - Tax Deferral
CHAPTER EIGHT - CAPITAL GAINS: BUSINESS RELATED
GAAR (General Anti-Avoidance Rule) under S245 provides CRA with significant potential
powers to deal with various Tax Avoidance (chapter 1) schemes including those relating to
capital gains.
CAPITAL VS INCOME RECEIPT
Recall from chapter 1 and the history above, that capital gains have always received favourable
tax treatment. Therefore, the issue of whether or not a specific gain is on account of capital or
some other form of income, is implicit in all dispositions. Review the concepts of PRIMARY
INTENTION and SECONDARY INTENTION, including the various criteria used to establish
INTENTION which were first introduced in chapter 4 and are discussed again in this chapter.
Note that a special election is available under S39 to individuals only, with respect to the
disposition of “Canadian Securities”, to have all such transactions treated as capital in nature.
It should be obvious that taxpayers prefer capital gains treatment to income treatment on profits,
but would prefer income treatment (100% deductible against any income) over capital gains
treatment in the case of losses!
CAPITAL GAINS RESERVES
S40 allows a reserve (temporary deduction or tax deferral) to be claimed where a portion of the
total proceeds of disposition is “not due” until after the end of the current taxation year. The
reserve is equal to the lesser of: a) a reasonable reserve = proceeds not yet due/total proceeds x
gain on disposition, and b) (4 - number of prior tax years ending after the year of disposition)/5 x
gain on disposition. The b) part of this formula ensures that a minimum cumulative capital gain
of 20% per year is reported in any case. Thus, the maximum period over which a capital gain
may be apportioned under this reserve is 5 years.
Any capital gains reserve claimed in one year is included in income the following year as a gain.
This ensures the integrity of the reserve system and allows a new reserve to be claimed the next
year subject to the constraints of the formula.
FOREIGN EXCHANGE GAINS & LOSSES - Currency exchange gains and losses must be
distinguished from the original transaction denominated in a foreign currency. That is the sale of
an asset in foreign currency must first be recorded in Canadian dollars. A subsequent conversion
of the foreign currency to Canadian dollars would give rise to a foreign exchange gain or loss, if
the rate of exchange was altered.
Common law principles must be applied to determine if the foreign exchange gain is on account
of income and fully taxable, or on account of capital and subject to capital gain/loss treatment.
For individuals, the net capital gain or loss from foreign exchange is reduced by $200 per year.
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