When you sell a capital property, your capital gain or loss for income tax purposes is calculated as your proceeds of disposition less your adjusted cost base (ACB) and any outlays or expenses relating to the disposition. In the case of shares acquired on the open market, your ACB is normally the cost of the shares plus any brokerage fees relating to the acquisition. However, there are other instances where the calculation is not so simple. The purpose of this article is to address some of the questions received on the subject from MoneySaver readers over the course of the past year.
If you own units in a mutual fund trust, you will receive a T3 information slip each year showing the income distributed to you from the fund. In the case of a mutual fund corporation, you will receive a T5. In either case, the slip will report any capital gains distributed to you from the fund during the year. However, what a lot of investors do not realize is that you also incur a capital gain or loss when you redeem units in the fund. This capital gain or loss is calculated as the proceeds you received from the redemption less the ACB of the units and your redemption fees. This is not reported on the T3 or T5 (although you should receive a T5008 Statement of Securities Transactions or account statement providing details relating to the disposition).
In most cases, your ACB will simply be the amount you paid for them plus any fees or commissions related to the acquisition. However, if you acquired additional units after your initial purchase, or you reinvested your distributions into the acquisition of new units, you will have to add these to the ACB. If you then redeem only a portion of your units, your ACB will then be calculated as their average cost. An example is shown in the table below.
If you own more than one mutual fund, you must track the ACB of each one individually.
Dividend Reinvestment Plans
Dividend reinvestment plans (DRIPs) allow registered shareholders to use their dividends to acquire additional shares in the company, usually at no charge and sometimes at a discount. Because the shares are identical properties, the cost of those acquired through the DRIP must be added to the cost of those acquired on the open market, just as reinvested distributions from mutual funds are added to the cost of the original units. Even though you do not receive the dividends in cash, they are still reported on a T5 slip and must be included in income. They are subject to the same gross-up and tax credit provisions as any other dividends from taxable Canadian corporations.
The CCRA takes the position that the 5% discount offered by some DRIPs does not constitute a taxable benefit to the shareholder. However, they state in an advance tax ruling that they do not take the same position with respect to any discount offered by the distribution reinvestment plans of unit trusts. In this latter case, the amount of the taxable benefit that you are required to include in income would also be added to the ACB of the units.
Employee Stock Options
When you exercise an employee stock option, you are considered to have a taxable benefit equal to the difference between the exercise price and the fair market value on that date. In the case of shares that are publicly traded, the benefit inclusion occurs when you exercise the option unless you elect to defer it until such time as you dispose of the shares. In the case of shares in a Canadian-controlled private corporation, the benefit inclusion always occurs when the shares are disposed of. In either case, the amount of the benefit is then added to the ACB of the shares, thus reducing the capital gain or increasing the capital loss when you sell them.
On September 1, 2001, Emily was granted an option to purchase 1,000 of her employer’s shares for $30 per share, the market price on that date. She exercised the option on September 1, 2002, when the shares were trading for $40 per share.
Assuming she does not elect to defer it, she will be required to include a taxable benefit of $10,000 in her 2002 income (calculated as $40,000 - $30,000). The ACB of the shares will be $40,000 ($30,000 + $10,000).
If she elects to defer the deferral, the taxable benefit and the adjustment to the ACB of the shares will occur in the year she disposes of them.
If you have also acquired shares in your employer’s company on the open market or through a stock purchase plan, the shares you acquired through a stock option agreement are normally subject to the usual cost-averaging provisions for the purpose of calculating their ACB. The one exception to this rule is if you dispose of the shares acquired through the stock option agreement within 30 days of exercising the option and do not acquire or dispose of any other of your employer’s shares during the intervening period. You may then choose to treat these shares as not being subject to the cost-averaging provisions.
Assume that Emily had also purchased 1,000 of her employer’s shares on the open market for $35 per share prior to exercising her option. If she did not sell the shares acquired under the stock option agreement within the next 30 days, the ACB of her 2,000 shares would be $75,000 ($35,000 + $40,000), or $37.50 per share. However, if she immediately sold the 1,000 shares acquired under the agreement, she could designate their ACB to be $40,000, or $40 per
share. The ACB of the shares bought on the open market would then remain at $35,000, or $35 per share.
Assuming a stock option agreement meets certain technical requirements, a stock option benefit will usually qualify for the 50% stock option and shares deduction. This does not affect the calculation of the ACB.
In the case of Canadian corporate spin-offs, part of the ACB of your original shares will normally be allocated to the new shares you acquire as the result of the spin-off. In the case of the spin-off of Nortel Networks from BCE in May 2000, for example, 69.21% of the ACB of your original BCE shares would have been allocated to your new shares in Nortel Networks. However, the percentage allocation will vary depending on the relative worth of the two companies. If you receive shares as the result of a spin-off, you should therefore contact the investor relations department of the company in question to determine how your ACB should be allocated.
In the case of foreign spin-offs, you are normally deemed to have received a taxable dividend equal to the value of the newly acquired shares. This will also constitute the ACB of the newly acquired shares. New rules announced in 2000 provide that in some cases you can elect to treat foreign spin-offs in the same way as Canadian spin-offs; that is, allocate a portion of the ACB of your existing shares to the newly acquired shares. However, this tax treatment is dependent on the foreign corporation providing the CCRA with detailed information about the spin-off. It is also presently restricted to U.S. corporate spin-offs.
Stock Splits and Consolidations
A stock split does not affect the total ACB of your shares in the company. However, it does affect the ACB of each individual share. It is therefore important to keep a record of how many times a stock has split. BCE shares, for example, split 3 for 1 on April 26, 1979 and 2 for 1 on May 14, 1997. So if you purchased 100 shares in Bell Canada Enterprises for $12 per share prior to 1979, you now own 600 shares with an ACB of $2 per share.
A consolidation is a reverse stock split. If you owned 100 shares with an ACB of $10 per share and the company consolidated its shares 1 for 10, you would therefore now have 10 shares with an ACB of $100 per share. At the time of writing, Nortel Networks was planning a stock consolidation in the spring of 2003. However, the consolidation ratio had not yet been announced.
Peter Coles, BA, MA, H&R Block Canada, National Office, 340 Midpark
Way S E, Suite 200, Calgary, AB, T2X 1P1. (403) 254-8689 firstname.lastname@example.org
Published with permission from Canadian MoneySaver. Subscription information and complimentary edition at www.canadianmoneysaver.ca
© 2007 The Globe and Mail. All rights reserved.
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