21 What are the superficial loss rules? What are the tax implications? Why do these rules exist?

There are many ways in which a person can try to avoid taxes on various things, one of these ways includes creating a loss just to reduce the taxable income. However, the Income Tax Act has rules to prevent people from deducting such false losses, these losses are also known as superficial losses.

Without the superficial loss rule a shareholder might sell shares at the end of the year to trigger losses to offset taxable capital gains in the year then immediately re-purchase the same shares.   The superficial loss rules were added in the Income Tax Act to help address these ‘fake’ sales.

ITA-54 states that a superficial loss occurs when the taxpayer (or an affiliated person as defined in 251.1(1)) has a loss from disposing a particular (capital) property, and then that taxpayer or any person affiliated(associated) with the taxpayer buys or has a right to buy the same or identical property (also known as “substituted property”) between the period of 30 days before to 30 days after the disposition of the particular property. (Identical/substituted property is any property which is the same in all material respects, and therefore there wouldn’t be a difference if one was to be substituted for the other)

However, in certain situations, the loss from a disposition of the property may not be considered a superficial loss. Situations such as:

• The property was sold because the taxpayer became or ceased to be a resident of Canada
• The property was sold because the property’s use was changed
• The property is sold because the owner passed away
• The property was sold due to the expiry of an option
• The property is sold to a shareholder due to the company/corporation shutting down.

If the loss is determined to be a superficial loss, the taxpayer cannot deduct it from their calculation of taxable income for the year. However, the superficial loss amount is added to the Adjusted Cost Base (“ACB”) of the identical property that was purchased.  By adding the superficial loss to the ACB the loss is deferred until the shares are permanently sold.

Let’s look at the tax impact of two identical scenarios with, and without, the superficial loss rules being applied

Illustration 1:  The superficial loss rule is not applied

Illustration 2: The superficial loss rules is applied.

In the second illustration you’ll see that the initial $300 loss is deferred and added to the ACB of the shares.  This reduces the gain when the shares are finally sold.

Interactive content (Author: Manpreet Singh, January 2020)

References and Resources:

• ITA – 54, 248(12)
• Article – “What is a superficial loss” (Author: Government of Canada)
• Article – “Meaning of Identical Properties” (Author: Government of Canada)
• Article – “Non-superficial losses” (Author: Government of Canada)
• Article – “What Is a Superficial Loss?” (Author: TurboTax Canada)

January 2020