Under the Income Tax Act (ITA), a superficial loss occurs on the disposition of a property where, during the period that begins 30 days before the disposition and ends 30 days after the disposition, the taxpayer (or a person affiliated with the taxpayer) acquires a property that is identical and continues to hold the property beyond the superficial loss period. Affiliated persons normally include a spouse or common-law partner and certain corporate, partnership and trust relationships including RRSPs, RRIFs, TFSAs and RESPs. Where a taxpayer’s capital loss is superficial, the loss is deemed to be nil and cannot be claimed for tax purposes. Consider the following example:
On January 2, Leigh sold 25 shares of XYZ corporation. Since their purchase, the shares had decreased in value, and because they were held on account of capital, a $1,000 capital loss was triggered at that time. Thereafter, on January 25, Leigh had a change of heart and repurchased all 25 shares of XYZ corporation. Because the repurchase occurred during the superficial loss period, Leigh’s $1,000 capital loss was deemed to be nil.
Despite the above, all is not lost with superficial losses. While the rules prevent these losses from being claimed immediately, for individuals, denied losses are normally added to the adjusted cost base (ACB) of the repurchased property, allowing for use of the capital loss on a future sale.
Although Leigh’s capital loss was deemed to be nil, section 53(1)(f) of the ITA allowed him to add the $1,000 loss to the ACB of his re-acquired shares, allowing for future use of the loss on the eventual disposition of the shares.
When discussing the superficial loss rule with clients, the question of identical property might come up. What defines identical property for these purposes? Canada Revenue Agency (CRA) interpretation bulletin IT-387R2R defines identical property as, “properties which are the same in all material respects, so that a prospective buyer would not have a preference for one as opposed to another.” The bulletin goes on to say that it is necessary to compare the inherent qualities or elements which give each property its identity, but know that a determination is a “question of fact” based on the details of each situation.
While the question of identical properties is a question of fact, it is likely that the superficial loss rule will apply where purchased property is the same in all respects to property that was, or will soon be, sold. A few points of note:
- The CRA considers index-based mutual funds from different financial institutions to be identical if they track the same index (eg. S&P/TSX Composite Index)
- Two properties that are otherwise identical do not cease to be so merely because one is subject to a charge which may affect its price while the other is not, provided the difference does not change any of the constituent elements of the property (eg. different series of the same mutual fund)
- While their investment mandates might be similar, a mutual fund trust and a similar class fund from a mutual fund corporation would not normally be considered identical properties for these purposes.
While we often talk about the superficial loss rule when describing the sale and repurchase of properties that are the same in characteristics and amount, in many cases partial dispositions can complicate the superficial loss calculation. Clients can also get caught off guard when participating in employer sponsored plans. Consider the following scenario:
Justin, an employee of STACKIT!, a publicly traded company, is part of the company’s employee share purchase plan. Justin contributes to the plan on a quarterly basis resulting in the purchase of common shares of the company. On May 15, Justin owned 90 common shares of STACKIT! with an adjusted cost base of $20/share and a fair market value of $5/share. Despite the decreased value of the shares, Justin decided to sell 50 shares at that time resulting in a $750 capital loss. Thereafter, within 30 days of the sale, Justin automatically repurchased 20 identical shares through the share purchase plan.
As Justin held the shares on account of capital, a capital loss was triggered on the sale of the common shares. Given that identical property was purchased within the superficial loss period (ie. beginning 30 days before the disposition and ending 30 days after), was Justin’s capital loss a superficial loss? If yes, what portion of the loss is deemed to be nil given that Justin did not repurchase all the shares that were sold?
The CRA has defined a formula that can be used to determine the amount of a superficial loss in the case of a partial purchase of identical property. The formula is as follows:
SL = (least of S, P and B)/S x L, where SL is the superficial loss, S is the number of items disposed of, P is the number of items acquired in the 61-day superficial loss period, B is the number of items left at the end of the period, and L is the loss on the disposition as otherwise determined without regard to the superficial loss rule.
Applying this formula to the above case, Justin’s capital loss would indeed be a superficial loss. Of the $750 capital loss, only $450 (or 60%) can be immediately claimed with $300 (or 40%) being deemed superficial. The calculation is as follows:
SL = (least of S (50), P (20) and B (60))/ S (50) x L ($750) = $300
With employer share purchase plans, it is unlikely that many clients are aware of the potential impact of the superficial loss rule when buying and selling shares within the plan, which can lead to tax reporting challenges. Where individuals fall prey to the superficial loss rule, they can take some comfort in knowing that their superficial loss can be added to the ACB of their repurchased property, allowing for use of the loss on a future sale.