Interest, dividends and capital gains are treated separately for tax purposes.
Investments earning interest such as GIC’s, Canada Savings Bonds, and corporate bonds are taxed at your current marginal tax rate. Interest must be reported whether or not was received in the year.
As part of the integration between corporate income taxes and individual taxes, dividends are taxed at a lower rate than income such as salaries. In simple terms, the individual is given credit for income taxes already paid by the corporation on the same income. The actual method to do this is to report as income, an amount greater than the actual dividends received but give a credit for the extra tax paid on another part of your tax return.
An investment sold at a price greater than your cost is said to have a capital gain for the difference. With a few exceptions, half of these gains are taxable at your current marginal tax rate. Capital gains tax rates have varied over the years and currently enjoy a low rate of tax as compared to other types of income. The rate is generally a result of the current government’s fiscal policy. Prior to 1972, there were no taxes on capital gains. The rates were as high as 75% of the tax rate on salaries to the current 50% of the tax rate on salaries. Personal residences can be sold without any capital gains taxes. Each family unit is allowed one personal residence under current rules. You may claim your regular home or vacation property as your personal residence. In prior years, each spouse was permitted to have a residence. There are transitional rules, which allow for planning opportunities upon the sale of the regular residence or vacation property. Investments in private Canadian corporations also have special rules, which if planned properly could result in some or all of the gain on sale as free from tax. There are many special and complex rules with respect to capital gains which should be reviewed if you have sold any kind of investment or real property during the year.
Investments in mutual funds and income trusts carry their own issues with respect reporting investment income and capital gains. Mutual funds are generally set up so any income earned within them is reinvested in more units. This income while not actually received by the individual is reported for tax purposes. Upon eventual sale of the mutual fund, this income will be added to the cost base, thus reducing the amount of capital gains reported. Income trusts are similar, except that in some cases, income is paid out in addition to some of the original capital invested. This repayment of capital serves to reduce the cost base of the investment and potentially increase the capital gain. It is extremely important that portfolio investments are tracked for income reinvestments, return of capital amounts, sales and redemption’s to properly record gains and losses when these investments are eventually sold.
Many people invest in tax shelters to save income tax. The most common of these are investments in oil and gas exploration as well as mineral exploration. In addition to these, certain investments in films, hotels and software are not uncommon. These investments are usually set up in the form of limited partnerships. Because of this structure, losses and income from these investments flow directly to the partners. In many of these ventures, it is expected that there will be large expenses in the beginning of a project followed by income at a later date. In the case of natural resources, there are special rules with respect to exploration and development expenses. Losses in the partnership and reported by the individual have the effect of reducing the cost base of the property. In many cases, the investment is successful and the partner sells their investment and reports a capital gain. If the sale price is the same as the purchase price the investor has exchanged losses fully deductible for tax purposes for gains taxed at only one half the individual's rate. In some cases, the investment never works out on its own merit and the investor has simply recorded the full amount of their investment as a tax deduction.
Individuals are allowed to claim as expenses, interest used on loans for the purposes of investing. Many people borrow off a line of credit for the purposes of investing in stocks, real estate and mutual funds. It is important that borrowing for personal purposes and investment purposes is tracked in detail. Failure to do so may result in a denial of interest expense. In addition, if the investments are sold and the proceeds used for something other than investments, the interest is no longer deductible.
Individuals can also claim fees for management fees with respect to their investments.
There are special rules with respect to transferring investment assets into an RRSP. If you have accrued gains on investments, these gains must be reported for tax purposes. Any accrued losses however are denied upon the transfer of investments to an RRSP.
Losses on sales of investments are generally only deductible against gains from investments. Losses can however, be carried back three years and carried forward indefinitely. Any unclaimed losses at death can be claimed against any sources of income.
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