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Tax Treatment of Capital Gains

April 7, 2015

Tax Question:

What is the tax treatment of capital gains in a corporation?

Facts:

Some corporations have resources available to invest in stocks, bonds, real property or other appreciating assets. Even though the value of such assets can appreciate over time, only when the investment is sold (realized), is a gain or loss reported. The gain or loss is calculated by taking the sale proceeds less the adjusted cost base of the asset and any related selling costs.

Discussion:

If the disposal results in a capital gain, then the gain is multiplied by an inclusion rate, currently 50%, to get a taxable capital gain. If a taxable capital gain is the result of the sale of a capital asset that was used to generate active business income in the company (i.e. the building the company operated out of), then the taxable capital gain is taxed at 13.5% (for BC Canadian Controlled Private Corporations on the first $500,000). However, if a taxable capital gain results from the sale of a capital asset not used to generate active business income, then it is taxed at 45.67%.

The non-taxable portion of the capital gain is then added to the Capital Dividend Account (CDA) which can eventually be withdrawn by the shareholder as a tax-free dividend. Furthermore, the taxable capital gain is also added to the aggregate investment income for Refundable Dividend Tax On Hand (RDTOH) purposes. If a capital loss is incurred, it too is multiplied by the inclusion rate to get an allowable loss. This allowable loss can only be applied to reduce taxable capital gains. It cannot be applied against non-capital losses.

The allowable loss can be used to reduce taxable capital gains incurred in the same year or, if there is an overall net allowable capital loss in the year that the assets are sold, this allowable loss can be carried back 3 years to reduce previous taxable capital gains or carried forward indefinitely to reduce future taxable capital gains. When an allowable loss is carried back to reduce previous taxable capital gains, the taxes paid on these taxable capital gains will be refunded. If the proceeds from the sale of the asset will be received over more than one tax period, a corporation may be able to claim a capital gains reserve. The reserve would allow the corporation to defer a portion of the gain in proportion to the sales proceeds not yet received over the total sales proceeds receivable thus reducing the amount of the taxable capital gain in the current year.

A minimum of 20% of the taxable gain must be recognized in the year of sale and each of the following four years. As with the majority of investment income, a corporation can claim an RDTOH on a portion of the taxes paid on the taxable capital gains if it pays a dividend to its shareholders. The amount of taxes refunded are in the ratio of $1 tax for every $3 dividend paid.

If you would like more information on this topic, please contact a member of the Empire CPA team by filling out the contact form below.

Canadian and foreign tax laws are complex and have a tendency to change on a frequent basis. As such, the content published above is believed to be accurate as of the date of this post. Before implementing any tax planning, please seek professional advice from a qualified tax professional. Empire, Chartered Professional Accountants will not accept any liability for any tax ramifications that may result from acting based on the information contained above.

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