CIFC Taxation of Investment Funds and Investor Accounts 2 — Questions and Answers
Question 1: What is a 'superficial loss' under Canadian tax rules, and what is its consequence?
- A minor capital loss under $200 that is fully deductible
- A capital loss that is denied when the same or identical property is repurchased within 30 days before or after the sale (Correct answer)
- A loss that occurs when a fund's NAV drops below its issue price
- A loss on foreign currency conversion that is not reportable
Correct answer: A capital loss that is denied when the same or identical property is repurchased within 30 days before or after the sale
A superficial loss is denied by the CRA when the investor (or an affiliated person) repurchases the same or identical property within 30 days on either side of the sale; the denied loss is added to the ACB of the reacquired property.
Question 2: An investor switches from Fund A to Fund B within the same mutual fund family. What is the tax consequence in a non-registered account?
- No tax consequence because both funds are in the same family
- The switch is treated as a disposition of Fund A, potentially triggering a capital gain or loss (Correct answer)
- The switch defers tax until Fund B is ultimately sold
- The switch generates only a return of capital distribution
Correct answer: The switch is treated as a disposition of Fund A, potentially triggering a capital gain or loss
For tax purposes, a switch between funds is a disposition of the original fund units and an acquisition of new units, which can trigger a capital gain or loss even if no cash changes hands.
Question 3: How does contributing to an RRSP reduce an investor's current-year tax liability?
- RRSP contributions earn a non-refundable tax credit equal to 15% of the contribution
- RRSP contributions are deductible from taxable income, reducing the amount of income subject to tax (Correct answer)
- RRSP contributions are matched by a government grant of 20%
- RRSP contributions are taxed at a flat 10% rate on withdrawal
Correct answer: RRSP contributions are deductible from taxable income, reducing the amount of income subject to tax
RRSP contributions are deducted directly from taxable income, so the tax savings equal the contribution amount multiplied by the investor's marginal tax rate.
Question 4: What happens to a capital loss that exceeds capital gains in a given tax year for a Canadian investor?
- The excess loss is forfeited and cannot be used
- The excess loss can be carried back 3 years or carried forward indefinitely to offset future capital gains (Correct answer)
- The excess loss can offset any type of income in the current year
- The excess loss is converted into a non-capital loss
Correct answer: The excess loss can be carried back 3 years or carried forward indefinitely to offset future capital gains
Net capital losses can be carried back three years or carried forward indefinitely, but they can only be used to offset capital gains, not other types of income.
Question 5: Foreign income (interest and dividends) earned inside a non-registered Canadian account is subject to which tax treatment?
- It is fully exempt from Canadian tax under international treaties
- It is included in Canadian taxable income and may be subject to foreign withholding tax, for which a foreign tax credit may be available (Correct answer)
- It is taxed at the preferential capital gains inclusion rate
- It qualifies for the Canadian dividend tax credit
Correct answer: It is included in Canadian taxable income and may be subject to foreign withholding tax, for which a foreign tax credit may be available
Foreign income must be included in Canadian taxable income in full, and while foreign withholding taxes may be deducted, a foreign tax credit can offset double taxation.
Question 6: What are the tax implications when RESP educational assistance payments (EAPs) are withdrawn and paid to a student beneficiary?
- EAPs are tax-free to the subscriber who opened the plan
- EAPs are taxable in the hands of the student beneficiary, who typically has a low income and low tax rate (Correct answer)
- EAPs are taxed as capital gains at a 50% inclusion rate
- EAPs trigger a full repayment of government grants received
Correct answer: EAPs are taxable in the hands of the student beneficiary, who typically has a low income and low tax rate
EAPs (which include grants and accumulated investment income) are taxable to the student beneficiary when withdrawn, but because students usually have little income, the tax owed is often minimal.
Question 7: Under Canada's attribution rules, what occurs when a higher-income spouse lends or gifts money to a lower-income spouse to invest?
- All investment income earned on the gifted/loaned funds is attributed back to the higher-income spouse for tax purposes (Correct answer)
- The investment income is split 50/50 between spouses regardless of contributions
- The lower-income spouse reports all income with no attribution
- The attribution only applies to capital gains, not income
Correct answer: All investment income earned on the gifted/loaned funds is attributed back to the higher-income spouse for tax purposes
Canada's attribution rules prevent income splitting by attributing investment income (and capital gains for gifts) back to the transferring spouse, eliminating the tax advantage of the strategy.
CIFC Taxation of Investment Funds and Investor Accounts 2
What is a 'superficial loss' under Canadian tax rules, and what is its consequence?