1CHAPTER 7 AND 8 - CAPITAL GAINS: AN INTRODUCTION (Div B, Subdiv c , S38-
Prior to 1972 capital gains were not taxed in Canada and capital losses could not be claimed.
The portion (inclusion rate) of a capital gain or loss which is taxable/deductible has changed since
then. [calendar 1972 to 1987 => 50%; calendar 1988 to 1989 => 66.67%; calendar 1990 to Feb
27, 2000 => 75%; Feb 28 to Oct 17, 2000 => 66.67%; Oct 18, 2000 to present => 50%]
Since 1972, each disposition of capital property requires a separate calculation of taxable capital
gain or allowable capital loss. Section 3(b) requires that allowable capital losses be offset against
taxable capital gains, except as discussed below for PUP (including LPP) and ABILs. If the net
result of all current year capital dispositions is a taxable capital gain, this amount is included in
Division B income. If the net result is an allowable capital loss, this amount is not deductible
currently since allowable capital losses can ONLY BE DEDUCTED AGAINST taxable capital
gains. (A net allowable capital loss for the current year can be carried over to other years under
Division C to be discussed in chapter 10.)
Allowable Business Investment Losses are effectively allowable capital losses, resulting from the
disposition of shares or debt of Small Business Corporations (CCPCs carrying on Active
Business), which are deductible against any type of income. (Ie not restricted to capital gains.) As
such they are identified and segregated from the net taxable capital gain/loss computation for the
year, and dealt with separately. This is effectivelyan additional tax incentive to motivate investors
to invest in Canadian small businesses.
CAPITAL GAINS DEDUCTION
The general capital gains deduction allowing resident individuals (not corporations) to earn in
their lifetime $100,000 of capital gains tax free, existed between 1985 and 1994. The deduction
was claimable only in the year of a capital disposition which gave rise to a capital gain. In 1994 a
final election to use any unused portion of the lifetime limit against unrealized gains which could
be supported by FMV appraisals was allowed. The benefit of the election was to increase the
ACB of capital assets which had increased in value but had not yet been subjected to a
disposition. This election may still be relevant in tax preparation today, where a taxpayer disposes
of property (say real estate) which was acquired prior to 1994 and on which an election had been
A further capital gains deduction allowing resident individuals to earn in their lifetime $750,000
(less any prior claims made under the general deduction above) of capitals gains tax free on the
sale of qualified Small Business Corporation shares or qualified farm properties only, still exists
This deduction again represents an additional tax incentive to motivate investors to invest in
Canadian small business and farm properties.
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! IT-459, IT-218R, IT-479R are useful resources on this topic.
Proceeds of disposition
less: Adjusted cost base
less: Costs of disposition
= Gain or Loss
less: Exemptions (S40 Reserve for amounts not yet due; Principal residence exemption)
= Capital Gain or Capital Loss
times: Current year inclusion rate
= Taxable Capital Gain or Allowable Capital Loss.
Capital gains or losses are only computed at the time of disposition. For tax purposes dispositions
include sales, but can also be “deemed” on change in use, death of the taxpayer, emigration of the
taxpayer from Canada and on gifting of the asset to another taxpayer. ACB computations begin
with accounting “laid-in cost” but may require adjustment for tax purposes in accordance with
sections 52 and 53 and the ITAR’s (for assets acquired prior to 1972). The applicable inclusion
rate is determined based on the date of DISPOSITION of a capital asset.
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
The disposition of Depreciable Capital Property can give rise to capital gains, but can never result
in a capital loss! This is due to the fact that a “loss in value” would be given a 100% deduction
under the CCA system. (To allow a capital loss in addition, would be double counting this cost
for tax purposes.)
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 minimumcumulative capital gain of
20% per year is reported in any case. Thus the maximumperiod 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. PRINCIPAL RESIDENCE EXEMPTION
Gains on the disposition of a Principal Residence may be exempted by Designating the resi