One of the consequences of COVID-19 is volatility in the stock market. Some investors facing losses in their portfolios are considering strategies to crystallize them and use the losses to offset capital gains. One-half of capital losses (referred to as an allowable capital loss) can be used to offset one-half of capital gains (referred to as a taxable capital gain). Unused capital losses (referred to as net capital losses) may be carried back three years or carried forward indefinitely but may only be used to offset taxable capital gains.
To generate cash flow, a person who realized capital gains in 2017 to 2019 may be tempted to trigger losses now and carry the loss back to offset the capital gains. In this way, cash flow can be generated by way of a refund of taxes paid.
The purpose of this commentary is to provide general tips to ensure that the capital losses will in fact be available to be used. The Income Tax Act (Canada) (the “Act”) contains rules that will either: (i) deny the loss from being claimed; or (ii) delay the claiming of the loss by adding the amount of the loss to the cost base of the property which will be relevant when the property is ultimately sold. The rules are highly technical and complicated. They are triggered by the number of days between the sale of the stock (that is, the settlement date) and the acquisition of it by certain persons, entities, trusts or partnerships. The rules are also triggered by who owns the stock during that period. Before proceeding with a plan, it is important to ensure that the losses will be available to be used as intended. A member of Miller Thomson’s tax group would be happy to discuss this with you.
Wait 30 calendar days to re-acquire the stock
A capital loss will be deemed to be nil under the superficial loss rules if the same stock is re-acquired by the person who disposed of it within 30 days. The amount of the denied loss is added to the cost base of the re-acquired shares and will be relevant to the calculation of a capital gain or capital loss when the stock is disposed of permanently. The difference is that the loss will only be available at that later time and not, say, in 2020. For this reason, it is critical that the number of days from the date the stock was disposed of is carefully determined.
Wait 30 calendar days to sell some of the stock
Suppose stock was purchased in 2020 and it has declined in price. If a decision is made to sell some but not all of the stock, the loss may be a superficial loss if the sale takes place 30 days after the original purchase. In this case, the denied loss will be added to the cost base of the remaining stock. If all of the stock is sold, the loss will be available provided that it is not purchased again within 30 days after the sale.
Pay attention to who acquires the stock and when
The superficial loss rules will also apply if the same stock is acquired within 30 days by an “affiliate” of the person disposing of the stock. The term affiliate generally includes:
- the person’s spouse or common law partner;
- a company controlled by the person, his or her spouse or common law partner, or combination thereof;
- a partnership in which the person is a majority-interest partner; or
- a trust in which the person is a majority-interest beneficiary.
Both the term majority-interest partner and majority-interest beneficiary are defined terms under the Act to mean those who, either alone or together with their affiliates, are entitled to more than 50% of the income, capital or distributions, as is applicable.
Where the stock is owned by a company, a partnership or a trust, the superficial loss rules may also apply depending on who acquires the stock within the 30-day period. The superficial loss rules will apply if it is acquired by any of the persons (including the companies, trusts and partnerships), referred to above.
The superficial loss rules will also apply if the stock is acquired by the person’s registered plan (including an RRSP, TFSA, RRIF or RESP) within the period noted above. In this case, the loss will effectively be permanently denied since adjustment to the cost base will take place in the registered plan.
The superficial loss rules are not triggered if the stock is acquired by a child or a parent of the person disposing of the stock.
Losses can be suspended or stopped
If the stock is sold by a company to a shareholder who controls it, the loss is suspended in the company’s hands until such time as the shareholder no longer owns the shares. Under the so-called “stop loss rules”, the loss can only be used at the time that the shareholder no longer owns the shares and the shares are owned outside of the affiliated group.
Similar rules apply where: (i) a company sells shares to another company that is controlled by the same person or group of persons; (ii) a trust sells the shares to certain beneficiaries; and (iii) a partnership sells the shares to certain partners. Any plan that is undertaken should be done in such a way to ensure that the loss will not be suspended or stopped.
A trust can only carry back a net capital loss if the taxable capital gain was subject to tax in the trust. This is not typically the case as it is usual for a trustee to allocate taxable capital gains to the beneficiaries. Thus, a trust that realizes a capital loss will usually only be able to carry the loss forward and use it to offset capital gains in the future.
Timing of a refund
If the goal is to trigger a capital loss to carry it back to offset capital gains in a prior year, it is important to remember that it will take some time for the tax refund to arrive. The process requires filing the tax return for the year in which the loss was realized, including the necessary forms to carry the loss back. The deadline for filing the tax return depends on the status of the particular person. For example, a tax return for an individual for the 2020 taxation year is due April 30, 2021 or June 15, 2021 if the individual is self-employed. A company’s tax return is due six months after its year end. The refund will be issued when a notice of reassessment has been issued for that prior year.
While this commentary has focussed on publicly traded shares, there are similar rules that apply to depreciable property and certain inventory.
The realization of capital losses could either generate a refund of taxes previously paid or reduce taxes payable in 2020 and future years. Before proceeding with a plan, it is important to confirm that the losses will be available to be used as intended. The technical and complicated superficial loss rules and the stop loss rules must be considered as part of any plan. Where the objective is to realize a capital loss that can be used to offset capital gains it is important that tax advice be sought. Do not hesitate to contact a member of the Miller Thomson Tax Group. We are here to help you.
Miller Thomson is closely monitoring the situation around the COVID-19 pandemic to ensure that we provide our clients with the appropriate support in this rapidly changing environment. For additional information, please see our COVID-19 resources page.