Finance Minister Paul Martin, in his 1994 budget, eliminated the $100,000 Capital Gains Exemption (CGE). The official deadline for taxpayers to claim any unused CGE was May 1, 1995. However, there is one final chance to trigger accrued gains up to February 22, 1994, and shelter those gains with available CGE. In addition, if you did choose to elect in your 1994 tax return to trigger accrued gains, this election is by no means permanent and can be amended or revoked if you feel it is advantageous to do so.
This article will outline what the time frame is for making a late election and the penalties for doing so. If you require general information with respect to the election process and its advantages and disadvantages, please e-mail us with your name and address and we would be happy to send you a copy of our original analysis of this subject.
If you filed an election with your 1994 tax return, you were treated as having disposed of the particular asset elected on as of February 22, 1994, and then to have immediately reacquired it at the elected value. You reported as income an "accrued" capital gain and claimed an offsetting deduction by using your remaining CGE. The accrued gain has been added to the original cost of the asset to form a new cost base. This new cost base will be used when calculating any future income tax payable on eventual sale.
The benefit of the election was to shelter accrued gains as of February 22, 1994 from tax when the eventual sale of the asset takes place.
Even though the May 1, 1995 deadline has passed, you have until April 30, 1997 to file the election and claim any unused CGE, provided you pay a penalty as prescribed at the time of filing the election. The penalty is 1/3 of one percent (0.33%) of the taxable capital gain to be sheltered for each month or part month that the election is late. Therefore, the longer you wait to make the election, the more costly it will be in terms of the penalty to be paid.
As an example, suppose you have now decided that you should have elected to trigger an accrued gain on an asset you owned at February 22, 1994. The fair market value of the asset is $10,000. The adjusted cost base of the asset is $5,000 leaving an accrued gain of $5,000. The taxable portion of the gain is 75% or $3,750. Therefore, the penalty per month is $3,750 x 0.33% or $12.50 per month. Six months have passed May 1, 1995 to October 1995. The total penalty then is 6 x $12.50 or $75.00 in total.
Obviously, the larger the gain triggered, the larger the penalty will be. You must therefore, weigh the potential penalties against possible future tax savings when the asset is disposed of. As a general guide, we have prepared the following table which outlines the dollar value per month of penalty from October 1995 to April 1997, based on $1,000 of gross capital gain:
| Month Of Election | Penalty Per $1000 Of Gain |
|---|---|
| October 1995 | $15.00 |
| November 1995 | $17.50 |
| December 1995 | $20.00 |
| January 1996 | $22.50 |
| February 1996 | $25.00 |
| March 1996 | $27.50 |
| April 1996 | $30.00 |
| July 1996 | $37.50 |
| October 1996 | $45.00 |
| January 1997 | $52.50 |
| April 1997 | $60.00 |
You can determine then, the approximate amount of your total penalty based on this guide.
If you have previously elected, you have until April 30, 1997 to amend your election. An election to increase the amount of the gain triggered is subject to the penalties outlined above. The penalty is based on the difference between the updated amount of taxable capital gain triggered and the original amount of taxable capital gain triggered. There is no penalty for revoking or reducing the amount elected.
You may only amend your election with respect to the same asset on which you originally elected. If you wish to elect on a different asset, you must cancel your original election and file a new election. There will be a penalty on such a transaction which must be factored in.
Recall the rule as set out previously, that if Revenue Canada determines upon review that, in estimating the fair market value of an asset, you exceeded 110% of the actual fair market value as determined by them, you will be subject to a penalty. In this case, you will not be able to amend or revoke your election.
There are legitimate reasons why you may want to amend or revoke your original election. If, for example, you elected on Asset Number 1, but have subsequently sold Asset Number 2, which you did not elect on, you could revoke your original election and elect on Asset Number 2 instead. A cost benefit analysis should be performed to see if this is beneficial.
Secondly, you may have been unpleasantly surprised at the side effects of using this election. All elections made had the effect of increasing your net income for income tax purposes by the amount of the taxable capital gain sheltered. Since net income is the basis for several calculations that affect income taxes payable, you may have found yourself in a position where your tax bill was higher than in previous years. For example, you may have been required to repay your Old Age Security, or you may have seen your credit for medical expenses decreased. By amending or revoking the election, you could alleviate yourself of this tax burden. However, the costs and benefits must once again be analysed.
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