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Superficial loss for a taxpayer, or not? CRA has rules …

If a share disposition is determined to be superficial, the capital loss is not allowable

by Ron Clarke

Do you have faith that some shares you currently own that were of high value when you bought them, but have now crashed, are going to skyrocket in value, or at least move north again?

Shares in the numerous cannabis corporations come to mind.

Some investors with this mindset will sell their current low value shares to take advantage of a seemingly lucrative capital loss, only to repurchase identical shares at the same time so that when the shares take off in value as they expect them too, they will sell them and receive the capital gain.

And, of course the newly acquired capital gain can be offset by that prior capital loss.

This is a trading scheme that is used.

However, in tax terms, this sell/buy/sell routine is defined as a superficial loss by the Canada Revenue Agency (CRA), and there are rules to prevent a taxpayer or an affiliated person, from taking advantage of this type of investment loss.

If a share disposition is determined to be superficial, the capital loss is not allowable.

The time frame of the sale of the shares and re-purchase of the identical shares is the key for CRA to determine the loss as superficial or not.

If the purchase of identical shares takes place within 30 days prior to the sale of the shares or within 30 days after the sale of the shares, then the sale of the shares and the associated capital loss is deemed superficial and denied as a claim on the person’s tax return.

To the earlier point of an affiliated person involved in the purchase of identical shares.

This includes a spouse, common-law partner, and also a corporation of which you or your spouse or common-law partner have controlling interest.

In logistical terms, this means one spouse can’t sell the shares and the other spouse repurchase them, CRA will determine this to be superficial loss.

Interestingly, children, parents or other relatives are not considered affiliated persons.

Regarding the definition of identical shares.

This refers to the same class of shares of the same corporation.

The quantity of shares sold and re-purchased does not have to be the same.

Likewise, the superficial loss rule applies to the sale and re-purchase of units of mutual funds and exchange traded funds (ETF) if they are in the same fund and same class of units.

Best of luck with the pot stocks.

The cash will be paid out as wages to the owner and therefore will be taxed at the higher personal tax rate.

Of course there will be no corporate tax since the “profit” has been expensed as wages.

Even if paid out as dividends to the owner, these funds come from after corporate tax dollars and then taxed personally, albeit at a preferred tax rate, nonetheless the benefit of the corporate taxation scheme is diminished.

In other words, whether paid as wages or dividends there may be little tax benefit for incorporation when all the profit has to be removed for spending to sustain personal life.

Conversely, if considerable profit can be retained within the business, then the tax benefit of incorporation will be significant.

Or is it that simple?

Investment income produced from retained earnings is considered passive income and only the first $50,000 of it is eligible for the 11 per cent tax rate, and amounts greater than $50,000 reduce the amount of eligible income to be taxed at 11 per cent.

To the extreme, the tax rate for the corporation could be 27 per cent, which is the tax rate for corporate income over $500,000.

So growing a large investment nest egg within a corporation is not necessarily the answer.

These points summarize the initial look-see at incorporation.

There are more complex scenarios with other options that may be applicable to consider.

To this end, consulting with legal and accounting professionals may be wise before making the decision whether to operate as a proprietorship or corporation.

Ron Clarke, owner of JBS Business Services in Trail, provides accounting and tax services.