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Tax Traps & Tips: Personal Tax Planning: Things To Do Before December 31st By C. Stewart Bullard, CA As each year draws to a close, many newspaper and magazine articles offer basic year-end tax planning ideas. In the midst of all these other offerings, the purpose of this article is to provide a more in-depth look at some higher value planning opportunities. Planning for capital gains and losses To begin with, taxpayers should review their investment activity for the year and determine their realized capital gains and losses. If a taxpayer has suffered a net realized loss, they should consider a loss carry back against net realized gains in any of the three prior years. If, on the other hand, the taxpayer has experienced a net realized gain, they should review their portfolio for any investments with unrealized losses. Any such investments that are not expected to recover in value should be disposed of-that way the loss realized can offset current year gains, and thereby reduce taxes payable. Capital loss carry forward balances should always be considered before engaging in any tax loss selling as they may also be used to offset current year gains. Note: 2003 is the last year in which taxpayers can carry back a net capital loss against taxable capital gains realized in the 2000 taxation year. And because the capital gains inclusion rate and marginal tax rates for 2000 were higher than for all subsequent years, triggering capital losses now and carrying them back to 2000 will yield the maximum tax recovery. Open-market sale There are many ways to trigger capital losses. The most obvious way is to sell the losing investments on the open market, but it's important to understand that, for tax purposes, the sale is considered to have taken place on the settlement date, not the trade date (the settlement date usually occurs a few days after the trade date). Therefore, if a taxpayer wants to use tax loss selling, they should confirm the last trade date for settlement in 2003 with their broker. Debt or shares of bankrupt corporations Where a taxpayer holds debt or shares of a bankrupt corporation, they may file an election to have a deemed disposition of the debt or shares for nil proceeds. This election is useful where the debt or shares are those of a de-listed or defunct corporation and there is no market or exchange upon which an arm's length disposition may be enacted. The election must be filed together with the taxpayer's tax return for 2003. With regard to debts, the taxpayer need only establish that a particular debt has become a bad debt in the current year to qualify for the election. With regard to shares, generally the corporation must be bankrupt or insolvent; however, practitioners should review the qualifying conditions to ensure their client is eligible. If the taxpayer makes the election, they will be deemed to have reacquired the debt or shares for nil cost, and might therefore be taxed on any actual subsequent disposition. Alternatively, the worthless debt or shares may be sold to an arm's-length party for a nominal amount on or before December 31st. A legal transfer agreement should be executed to substantiate the disposition-otherwise the CCRA might deny the loss upon audit. Note: It may be possible to claim an "allowable business investment loss" on the deemed disposition. Transfer to spousal trust A capital loss may also be realized by transferring the loss investments to a spousal trust at fair market value (FMV). This method has the added benefit of allowing the taxpayer to retain control of the loss investments. Normally, a loss realized on the transfer of investments by an individual to an "affiliated person" will be denied by the stop loss rules, which deem the amount of a "superficial loss" to be nil. A superficial loss generally occurs when a taxpayer or affiliated person acquires an identical property within 30 days (before or after) the loss transaction and still owns the property at the end of that 60-day period. However, a spousal trust is not considered an affiliated person, and therefore the loss triggered will not be a superficial loss. Note: Transfers of property to a spouse or a spousal trust are deemed to take place at the taxpayer's "adjusted cost base," and an election must therefore be filed for the transfer to take place at FMV. This election must be filed together with the taxpayer's tax return for 2003. Transfer capital losses to a spouse The superficial loss rules can be used to transfer capital losses between spouses. This is useful in cases where one spouse has realized capital gains and the other holds investments with unrealized capital losses that aren't expected to recover in value. The loss investments are transferred to the taxpayer's spouse at FMV, and an election must be filed for the transfer to take place at that value. Because the transfer takes place at FMV, there will be no attribution of any subsequent gain or loss. The superficial loss rules will deny the loss realized on the transfer, provided the recipient spouse still owns the property 31 days after the transfer. However, the denied loss will be added to the recipient spouse's adjusted cost base of the property. The investments will then be sold on the open market to realize the loss, which can then be used to offset the recipient spouse's current year gains, or be carried back to a prior year. The CCRA has commented favourably on this strategy in numerous technical interpretations.1 (Note: Because the recipient spouse must hold the investments for 31 days and then sell them on the open market for settlement in 2003, this strategy must be started in mid-November.) What not to do - transfer to an RRSP A contribution in kind of investments to an RRSP will result in a deemed disposition at FMV that will trigger a capital gain or loss. Where a loss results, it is denied and there are no adjustments to any tax balances. The denied loss simply vaporizes. If your client wishes to transfer losing investments to their RRSP, the investments should be sold on the open market, with the proceeds then contributed to the RRSP and used to reacquire the same investments. The superficial loss rules will not apply, as a trust governed by an RRSP is not considered an affiliated person. Planning for an allowable business investment loss Unlike capital losses, which can only be applied against capital gains, an "allowable business investment loss" (ABIL) can be applied against any source of income. A "business investment loss" is a loss realized on the disposition of shares of a "small business corporation" or debt of a "Canadian-controlled private corporation" that is a small business corporation. The allowable portion is one half of the realized business investment loss. Where the taxpayer has previously claimed a capital gains deduction, the amount of the ABIL will be reduced. To trigger the ABIL, the taxpayer can sell the debt or shares to an arm's-length party at FMV, as discussed above. Planning for instalment payments Taxpayers who are required to make instalment payments should review their 2003 income before making their December 15th payment, because, if their total income for 2003 is significantly less than the prior year, the December 15th instalment may not be necessary. This article is not intended to substitute for competent professional advice. No action should be initiated without consulting a professional advisor. C. Stewart Bullard, CA, is a tax manager with Deloitte & Touche LLP in Vancouver. He thanks Norm Yurik, CA, and Christina Diles, CA, of Deloitte & Touche LLP for their assistance in preparing this article. Endnote
Corrections In the October 2003 Cover Story under "Relief for 'small-cap' companies," the following sentence should have read: "A listed entity is defined as an entity listed on a recognized stock exchange that has, in respect of a particular fiscal year, both market capitalization and total assets of more than $10 million each." In the October 2003 Ethical Dilemmas, the individual referred to as "Ted" throughout most of the article was mistakenly referred to as "Tom" several times in the second column. In both cases, we apologize for any confusion.
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