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Are Your Investment Gains and Losses Capital or Income?
For most taxpayers, their gains and losses from the sale of securities are treated as capital gains and losses. This means 50% of the gains are taxed instead of 100%. A capital loss can only be used to reduce or eliminate capital gains.
For some taxpayers, such as day traders, the gains and losses are determined to be business income, not capital. This means 100% of the gain is taxed, and 100% of a loss is deductible. The business loss is deductible from other income, and if the loss exceeds other income it becomes a non-capital loss. Both the conduct and intentions of the taxpayer are examined to determine whether to treat the securities transactions as income or capital. The combination of a number of the following factors may cause the gains or losses to be treated as income (100% taxable), not capital (50% taxable):
If your investment income is business income, you will complete form T2125, Statement of Business or Professional Activities. You will not enter anything on your tax return from your T5008 document.
A person is "short" a security when they sell shares they do not own, by borrowing them from their brokerage company. This is called making a "short sale", or "selling short". This is normally done when the person believes that the price of the security is going to fall, so that they can cover the sale by buying back the stock later at a lower price. See also "long".
The profit or loss on the short sale of shares is usually considered to be an income gain or loss, unless an election has been made under s. 39(4) to treat them as capital transactions, if they are Canadian securities. In Federal Court of Appeal Rezek v. Canada (2005 FCA 227), it is stated that any broker's fees, rental fees and compensatory dividends paid by the short seller between the short sale and the close out will reduce the profit or increase the loss.
As per s. 39(5) of the Income Tax Act, the s. 39(4) election "does not apply to a disposition of a Canadian security by a taxpayer who, at the time of the disposition, is
or any combination thereof."
When is the gain or loss from the short sale of shares included in taxable income?
This is a very good question, and there is little documentation available to answer it. We did find a couple of helpful Tax Interpretations.
Tax Interpretation 2010-0364991E5 - Transaction in securities indicates that "the gain or loss is realized only when the short sale transaction is closed. A short sale transaction is considered completed only when the short seller already owns or purchases identical shares and returns the same to the lender, thereby, settling the obligation. Where the short seller satisfies the obligation by borrowing an identical security from a different broker, it does not close the short position of the initial borrowing, i.e., the constant borrowing of shares to repay the previous lender does not close out the short position."
Tax Interpretation 2014-0559281E5 F - T5008 provides information on how short sales of stocks should appear on the T5008 slip. The short sale must be reported on the T5008 slip by the dealer in the calendar year in which the sales are made.
It is possible that a taxpayer may have some securities transactions which are capital transactions, and in the same year have other securities transactions which are income transactions. For example, a day trader could have two investment accounts, one for day trading, and one for investments which are not frequently traded, and are held as long term investments.
For RRSPs and RRIFs, s. 146(4)(b) and 146.3(3)(e) specifically exclude from business income any business income from qualified investments, or from the disposition of qualified investments. This means that someone could engage in day-trading in their RRSP or RRIF without being taxable on the business income until the income is withdrawn. This exclusion does not apply to other registered accounts, such as Tax-Free Savings Accounts. See links below.
Excellent article on whether stock transactions are capital or income: Vern Krishna: Stock Traders Beware of Tax Traps: The Taxman Cometh
This topic is discussed in the April 2021 Life in the Tax Lane video from Video Tax News.
A taxpayer can elect under s. 39(4) of the Income Tax Act to have their transactions in Canadian securities to be treated as capital transactions. The election is made by filing Form T123 Election on Disposition of Canadian Securities, and applies for Quebec taxation purposes also (as per Quebec Taxation Act s. 250.1). Quebec taxpayers must enclose with their Quebec income tax return a copy of any document that was sent to the CRA regarding the election, including form T123 and the federal income tax return. See the Quebec publication IN-120-V Capital Gains and Losses. This election cannot be made for securities owned by
The election applies to all sales of Canadian securities by the taxpayer in the year of the election or future years, and cannot be rescinded. The term "Canadian securities" is defined in s. 39(6) of the Income Tax Act as a security (other than a prescribed security as described in s. 6200 of the Income Tax Regulations) that is a share of the capital stock of a corporation resident in Canada, a unit of a mutual fund trust or a bond, debenture, bill, note, mortgage, hypothec or a similar obligation issued by a person resident in Canada. According to the CRA interpretation bulletin IT-479R (link below), a Canadian security includes such a security that is sold short.
Trade Date or Settlement Date - When are Gains or Losses Recorded?
Canada Revenue Agency (CRA) and Revenue Quebec ResourcesCRA IT-479R Transactions in Securities (Archived) - see paragraphs 11 to 13 re some of the factors to be considered in ascertaining whether the taxpayer is carrying on a business.
Tax Tip: If you're not sure, get advice from a tax professional!
Revised: October 26, 2023
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