In my previous column, we defined a capital gain and explained the typical considerations when calculating adjusted cost basis (ACB) and the proceeds of disposition (POD). This article will examine special considerations and exceptions when calculating capital gains.
Gifts of publicly traded securities to charities are included at 0% (as opposed to 50%) for taxable capital gain purposes. Therefore, any inherent capital gains triggered when securities are donated in kind generate a $nil tax liability. As well, the donor receives a charitable donation slip representing the FMV of the securities donated. Often, when evaluating a client’s philanthropic wishes, a gift of securities is preferred.
Here’s an example. Say Mrs. Anderson wants to donate $10,000 to a Canadian charity where she volunteers. Mrs. Anderson calls her advisor to sell securities to fund the donation. She currently has several mutual funds with significant accrued gains. Fund A has a FMV of $20,000, and an ACB of $12,000. If you were Mrs. Anderson’s advisor, what would you suggest?
There are two options: selling units of Fund A to generate a $10,000 cash donation, or donating $10,000 worth of Fund A units in kind.
|Cash donation of $10,000||Donation of shares in kind|
|Proceeds of disposition||$11,000||$10,000|
|Adjusted cost basis||($6,600)||($6,000)|
|Taxable capital gain||$2,200||N/A|
|Taxable capital gains tax rate, 45%||($990)||N/A|
|After-tax proceeds to fund donation||$10,010||$10,000|
|Donation tax credit rate, 40%||($4,000)||($4,000)|
As Mrs. Anderson would have to dispose of additional units of Fund A to cover the tax liability resulting from her disposition if she chooses to donate cash, it is recommended she donate the units in kind.
For individual taxpayers who have donated securities in kind, the disposition is not reported on Schedule 3 Capital Gains (or Losses) for (Taxation Year), but rather on form T1170 Capital Gains on Gifts of Certain Capital Property.
Miscellaneous disposition of foreign currency, such as the conversion of foreign currency or traveller’s cheques denominated in foreign currency to another currency is to be reported on account of capital. In the case of individuals, Canada’s Income Tax Act says that only amounts in excess of $200 need to be reported for tax purposes.
From a foreign exchange perspective, any additional income/expense or gain/loss resulting from a foreign exchange component is linked with the resulting transaction. So, if a security purchased and disposed of in a foreign currency is treated on account of capital, any additional gain or loss from the disposition from foreign currency is also treated on account of capital.
Here’s an example. Say Mr. Zhang bought 1,000 shares of Apple in October 2011 when it was priced at US$55 (US$1 = CA$1.02). He sold 500 shares in October 2016 for US$107 (US$1 = CA$1.32). What is Mr. Zhang’s capital gain to be reported on his 2016 T1?
(500*$107*1.32) – (500*$55*$1.02) = $70,620 – $28,050 = $42,570
Gains and Canadian mutual fund investors
Mutual fund investors (individuals, corporations and trusts) should know there are two levels of capital gains reporting: gains that are reported at the fund level, and those triggered by the investor.
When a fund manager sells holdings in a particular mutual fund and realizes a capital gain, the capital gain may be passed to the unitholder (or shareholder for corporate-class funds) through a fund distribution. Capital gain fund distributions are reported in box 21 Capital Gains on a T3 (trust pools) and box 18 Capital Gains Dividends on a T5 (corporate-class funds). If the distribution is reinvested, it increases the investor’s ACB for tax purposes.
For non-registered accounts, clients who redeem or trigger a disposition of units or shares will also need to report the disposition and the resulting capital gain (or loss) triggered on their respective annual tax returns. Such transactions occur when units or shares are redeemed for investment counsel fees, the client’s portfolio is rebalanced, or if the client redeems or withdraws cash triggering a redemption.
Investors in segregated insurance funds should note that both fund and investor level capital gains (and losses) are reported on the T3 collectively, while mutual fund trust and corporation dispositions by an investor are normally reported on a capital gain or loss summary on year-end statements.
As we have learned, the tax rules overseeing the calculation and reporting of capital gains are complex. If a client has disposed of capital property, and is unsure of the reporting and taxation of such, refer them to a competent tax advisor.