CSC Canadian Taxation for Investors 3 — Questions and Answers
Question 1: How does the adjusted cost base (ACB) affect the calculation of a capital gain or loss in Canada?
- ACB is irrelevant; gains are based on the current market value alone
- ACB represents the original purchase cost plus commissions, subtracted from proceeds to determine the gain or loss (Correct answer)
- ACB is set by the government and cannot be modified by the investor
- ACB only applies to real estate, not to securities
Correct answer: ACB represents the original purchase cost plus commissions, subtracted from proceeds to determine the gain or loss
The capital gain or loss equals the proceeds of disposition minus the ACB (original cost plus allowable additions) and any selling costs.
Question 2: An investor contributes $6,000 to a TFSA and earns $400 in dividends within the account. What is the tax treatment of the $400?
- The $400 is added to taxable income for the year
- The $400 is tax-free while inside the TFSA and tax-free when withdrawn (Correct answer)
- The $400 is taxed at a special TFSA rate of 15%
- The $400 reduces the investor's TFSA contribution room
Correct answer: The $400 is tax-free while inside the TFSA and tax-free when withdrawn
All income earned within a TFSA — dividends, interest, or capital gains — grows completely tax-free and is not taxed upon withdrawal.
Question 3: Which of the following is NOT deductible against investment income in a Canadian non-registered account?
- Interest paid on money borrowed to earn investment income
- Carrying charges such as investment management fees
- Safety deposit box fees for storing investment certificates
- Commissions paid to purchase securities (Correct answer)
Correct answer: Commissions paid to purchase securities
Brokerage commissions paid to purchase securities are added to the ACB rather than deducted as an expense; they reduce capital gains on eventual disposition.
Question 4: A Canadian resident receives $1,000 in interest from a GIC held in a non-registered account. How is this taxed?
- At the capital gains inclusion rate of 50%
- At the eligible dividend gross-up rate
- As ordinary income at the investor's marginal tax rate (Correct answer)
- It is exempt from tax as passive income
Correct answer: As ordinary income at the investor's marginal tax rate
Interest income is fully included in taxable income and taxed at the investor's marginal rate — it receives no preferential treatment like dividends or capital gains.
Question 5: What happens to unused TFSA contribution room at the end of the year?
- It is forfeited permanently
- It carries forward indefinitely to future years (Correct answer)
- It is converted into RRSP room automatically
- It expires after 5 years if unused
Correct answer: It carries forward indefinitely to future years
Any unused TFSA contribution room accumulates and carries forward indefinitely, allowing investors to contribute more in future years.
Question 6: Which of the following best describes the concept of 'return of capital' distributions from an investment fund?
- A return of the investor's own cost, which reduces ACB rather than being immediately taxed (Correct answer)
- A special dividend that is taxed at the highest marginal rate
- A distribution that must be reinvested within 60 days to avoid tax
- A refund of previously paid taxes from the fund
Correct answer: A return of the investor's own cost, which reduces ACB rather than being immediately taxed
Return of capital is not immediately taxable; instead it reduces the investor's ACB, which results in a larger capital gain (or smaller loss) when the investment is eventually sold.
Question 7: Under the Canadian tax attribution rules, if a high-income spouse lends money interest-free to a low-income spouse to invest, who pays tax on the investment income?
- The low-income spouse, since the money is in their name
- The high-income spouse, because attribution rules apply to interest-free spousal loans (Correct answer)
- The couple splits the income 50/50 regardless of who earned it
- No tax is owed because interspousal transfers are exempt
Correct answer: The high-income spouse, because attribution rules apply to interest-free spousal loans
Attribution rules attribute investment income (and capital gains on certain property) back to the transferring spouse when loans are interest-free or below the prescribed rate.
CSC Canadian Taxation for Investors 3
How does the adjusted cost base (ACB) affect the calculation of a capital gain or loss in Canada?