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Recognizing the Difference Between Business Income and Capital Gains

August 24, 2020

How to handle the CRA if you’ve made an error on your income taxes, including information on the Voluntary Disclosure Program.

The sale of stocks/investments or various other capital property can represent an important tax break for those who’ve realized gains over time. However, often there is a fine line between what the government considers regular business income and capital gains. Today’s blog is dedicated to helping you recognize the difference between business income and capital gains – a somewhat muddy but essential task.

Is it a capital gain or business income? Capital gains are taxed at only half (50%) of the capital gain on any given sale, at your marginal tax rate (which varies by province). This is why it is crucial to correctly identify the differences – both at the beginning, to avoid overpaying, and after an assessment, so that you don’t end up owing thanks to an incorrect differentiation. So, what are those differences?

According to the Canada Revenue Agency, you typically have a capital gain when you sell or transfer capital property for more than you paid for it (the adjusted cost base) less any legitimate expenses associated with its sale. The two most common types are securities and real estate.

According to the Income Tax Act, the term ‘business’, in reference to the capital gains debate, includes “adventure in the nature of trade”. This means that any gains you make as part of the nature of your business are considered business income. For example, if you are in the retail industry, the differentiation is clear – product bought to be sold would clearly be considered business income. With other property though, that difference is not as clear.

Real estate is often the most tricky. To make it easier, the CRA has outlined several factors which impact the determination, such as intention, location, time held, and motivation. You can view the list in its entirety here:

What about stocks and shares or other investments? When it comes to shares of corporations and other securities, such as bonds and mutual fund units, the CRA typically considers the holding of such securities as capital property. That being said, if you actively trade, buying and selling shares on a regular basis and holding them for only short periods of time, this would be considered more of a ‘nature of the trade’ type scenario, and the capital gains tax rate would not apply.

The definition often comes down to intention. Basically, if you buy a ‘property’ with the intention of selling it, then you are considered to be in business and the gain will be fully taxed as business profit.

Want some help determining what you should be claiming, or know that you claimed capital gains/losses which should have actually been business income and want to make a correction? Contact Farber Tax today.