What Is Tax Loss Selling In Canada?
Want to understand the concept of tax loss selling and how it affects the stock market investing? Read this blog to find out.
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A securities market is synonymous with volatility. There is a consistent rise and fall in the stock prices because of various factors, such as
- Market forces of demand and supply
- The general sentiments prevailing among the market participants
- The governing authorities, such as the Bank of Canada and the Canadian Securities Administrator, made recent announcements.
- The changes in the political stability and overall government structure
An investor who bases investment decisions on the company fundamentals and popular technical indicators can often earn profits and enjoy successful trading.
But have you ever heard of the strategy of incurring losses deliberately?
What Is the Meaning of Tax Loss Selling?
Tax-loss selling is a unique investment strategy in which a stock market investor deliberately sells its securities at a loss. It usually happens when a stock market investor sells the securities at a spot price (also known as Current market price (CMP), which is lower than the purchase price.
What Is the Capital Gains Tax Rate in Canada?
A capital gain arises when you sell/ transfer any capital asset at a price higher than the purchase price. Conversely, if you sell capital assets at a lower price than you bought, this will lead to a capital loss.
The current capital gains tax rate prevailing in Canada is 50%. It means that it will tax all the taxable gains earned by you in a financial year at a flat rate of 50%. Suppose you have capital gains of $5,000 in a financial year. You need to pay $2,500 in taxes.
What Is the Offsetting Benefit of Tax Loss Selling?
As per the present Canadian Taxation Laws, assesses can set off their taxable capital gain with the capital loss incurred.
Such an offset reduces the taxable capital gains and, finally, the income tax liability. Further, such capital losses can be:
- Carried forward indefinitely
- Used to setoff capital gains earned in the previous three years
What Is the Purpose of Tax Loss Selling?
The primary purpose of tax-loss selling is to save capital gain taxes. Investors deliberately incur losses in the securities market to reduce their taxable capital gains income.
By selling the securities at a loss, such investors can generate a capital loss that the capital gains earned can offset. It reduces the taxable capital gains and ultimately lowers the tax burden.
Let us gain a practical understanding of this concept.
For Example,
Mr. X is a stock market investor, and he has invested in various equity stocks of different business organizations. Below is a list of all the securities held by him:
| Name of the Company | Quantity of Equity Stocks | The Purchase Price Per Stock | Current Market Price |
| XYZ Corporation Inc. | 500 | $35 | $28 |
| TYUP Manufacturing Inc. | 250 | $20 | $25 |
| PKLO Trading Inc. | 650 | $12 | $20 |
Alex relies on Bollinger Bands and Relative Strength Index (RSI) (both are technical indicators) for predicting future price movements. Acting upon his predictions and market analysis, he squared off his investments in TYUP Manufacturing Inc. and PKLO Trading Inc. at $25 and $20, respectively.
It generated the following capital gains for Alex:
| Name of the Company | Quantity of Equity Stocks | Selling price | Purchase price | Capital Gains |
| TYUP Manufacturing Inc. | 250 | $25 | $20 | $1,250 250 * ($25 – $20) |
| PKLO Trading Inc. | 650 | $20 | $12 | $5,200 650 * ($20 – $12) |
| TOTAL | $6,450 |
If Alex holds on to his investments in the XYZ Corporation inc, he will be required to pay the taxes on capital gains to the tune of:
Tax Liability=50% of $6,450
Tax Liability=$3,225
Now, Alex, being a veteran investor and a tax expert, engaged in tax-loss selling and deliberately sold his holdings in XYZ Corporation Inc. at a loss. It generated a capital loss for Mr. X in the following manner:
| Name of the Company | Quantity of Equity Stocks | Selling price | Purchase price | Capital Loss |
| XYZ Corporation Inc. | 500 | $35 | $28 | $3,500 500 * ($35 – $28) |
| TOTAL | $3,500 |
As per the present Canadian Taxation Laws, you can offset the capital loss of $3,500 against the capital gains incurred in the following manner:
Taxable Capital Gains (after offset)=$6,450−$3,500
Taxable Capital Gains (after offset)=$2,950
The revised tax liability would be:
Tax Liability=50% of $2,950
Tax Liability=$1,475
The technique of Tax loss selling reduced Alex’s tax liability by a whopping 55%.
Is Tax-Loss Selling Legal in Canada?
Absolutely, YES. Nothing illegal when an investor wants to sell the securities lower than the purchase price. It is a legitimate way of saving taxes and comes under the ambit of tax planning.
Conclusion:
Tax-loss selling is a process stock market investors can follow to sell their securities at a lower price than their purchase price. It leads to capital losses creation, which the investor can use to reduce the taxable capital gains. Investors, to reduce their tax burden, use this technique widely.
