Let’s face it, analyzing tax rates is nobody’s idea of fun. However, everyone loves saving on taxes! Read on to learn more about the tax on stocks in Canada – and how you can reduce the amount of taxes you pay on your investments.
How are stocks taxed in Canada?
It depends. There are many ways to hold stocks as investments. You can keep them in your Registered Retirement Savings Plan (RRSP) or your Tax-Free Savings Account (TFSA). Alternatively, you can open a non-registered account.
The tax treatment is different for each option:
- RRSP: These accounts are great for interest-earning investments and stocks that pay dividends. The stock value can grow tax-free and you don’t pay any tax until the funds are withdrawn. However, you will face tax when you take out the money.
- TFSA: There is no tax on a TFSA. You put the money in and it grows through reinvestment. When you make a withdrawal there is no tax. So, a TFSA is a great avenue for any investment, including stocks.
- Non-registered accounts: You have to pay tax on any dividends or capital gains when you sell your stock.
So, at first glance the RRSP and TFSA accounts seem to have advantages over non-registered accounts. However, a non-registered account can be valuable because capital gains receive preferential treatment over interest and dividends.
We will look at this question below.
What is the capital gains tax?
There is actually no official term “capital gains tax” in Canada. However, you must treat as income any capital gain on a stock when you sell. For example, let’s say you purchased $1,000 worth of stock and later sell it for $2,000. Your capital gain is $1,000.
The good news is that only 50 percent of the capital gain is taxable. So, in this example, you would be taxed on only $500 of the $1,000 capital gain.
Capital gains apply to individual stocks you own, as well as mutual funds and Exchange Traded Funds (ETF).
It can be advantageous to hold stocks in a non-registered account and leave the highly taxed dividends and interest-bearing investment vehicles in your TFSA or RRSP. That’s because your RRSP is not taxed until you withdraw the funds; and your TFSA is never taxed.
How much tax do you pay on stocks?
Of course, this depends on your net income, which determines your tax on stock gains.
As we have indicated, you only pay tax on half the capital gains when you sell a stock. You are taxed on all interest income. Dividends are fully taxed, but you may also be eligible for a dividend tax credit, which reduces the tax owing.
There is no specific capital gains tax rate. You pay tax based on your tax bracket, which is determined by your income. The only savings with capital gains is that you only pay tax on half of the gain.
What is a capital loss?
When you buy a stock, of course you are hoping it will go up in value. However, if you lose money on it and decide to cut your losses and sell, you may save some money on taxes.
That’s because you can use your capital losses to offset your capital gains. For example, let’s say you gained $1,000 in buying and selling Company X. During the same year, you lost $500 on Company Y and sold your shares. Therefore, you can subtract your loss from your gain – giving you a capital gain of $500. Furthermore, only half of this gain is taxable; you only pay tax on $250.
How to calculate a capital gain
Ottawa uses some fancy terms to calculate capital gains, but it’s actually pretty straightforward. The phrase “adjusted cost base” simply means the price of the shares you purchase, plus any fees the brokerage may charge.
Similarly, when you sell the shares you use the selling price and deduct any fees. The capital gain is calculated by taking this selling figure and deducting the adjusted cost base.
Let’s look at an example:
Sunny purchased $1,000 worth of Company B. There was a $10 brokerage fee and therefore the total cost, the “adjusted cost base”, was $1,010. She later sold the shares for $1,500 with a $10 fee. Therefore, the net sale value was $1,490.
The capital gain is calculated by taking the net sale value of $1,490 and subtracting the adjusted cost base of $1,010. Therefore, the capital gain was $480. Again, only half of this is taxable.
How to calculate a capital loss
While Sunny had success with Company B, she didn’t do well with her purchase of Company C. After she purchased the Company C shares for $2,000 the stock market experienced a downturn. The shares fell to $1,800 and she decided to cut her losses and sell. With the brokerage fees, she incurred a capital loss of $220.
As we indicated, there is a silver lining here. Sunny was able to claim the capital loss against her capital gain on Company B. This allowed her to take the capital gain of $480 and subtract the capital loss of $220. This means that the overall capital gain for the year was $260. Only half of this is taxable so she had to pay tax on $130 of her stock gain.
How to reduce your capital gain tax
When it comes to investments, there are three main ways to reduce the tax on stock gains:
- Sell losing stocks: As we indicated in our example above, you can subtract capital losses from capital gains. However, you must make the decision to sell – a capital loss isn’t realized until you actually get rid of the stock. For this reason, many investors make a decision to sell their clunkers before the end of the year. It allows them take advantage of the capital loss to reduce their capital gain. And, of course, this cuts their capital gains tax payable.
- A TFSA: This is one of the best ways to reduce capital gains tax. When you put money into a TFSA, you can earn interest, dividends and capital gains without paying any tax. Even when you withdraw the money, you can do so tax free.
- An RRSP: With an RRSP, you can accrue capital gains inside the account without paying tax. However, when you withdraw funds, you will face a tax bill. The key here is that you will be taxed based on your current tax bracket. Therefore, it’s best to withdraw funds when you have little other income as you will be in a low tax bracket.
No one want to pay taxes, so take advantage of all available options to reduce the amount of tax on stocks in Canada.
