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24.3.1 Disposition Of Shares

Comprehensive guide on determining capital gains or losses when disposing shares, principles of adjusted cost base, and considerations for warrants, rights, and stock dividends in Canadian taxation.

Disposition Of Shares

To determine a capital gain or loss, the general rule is to subtract the cost of the investment from the proceeds of the sale. The proceeds of the sale refer to the selling price multiplied by the quantity (shares, units or face value) of the investment sold. Calculating the cost of the investment to determine the capital gain involves finding the adjusted cost base (ACB), which establishes the investment’s cost for tax purposes. The ACB of shares sold is generally composed of the total purchase cost plus commission expense.

Example

Hilde buys 100 ABC common shares at $6 per share and pays a $17 commission on the purchase. Two years later, she sells the 100 shares at $10 per share, with a sales commission of $25. In the year of sale, the client’s taxable capital gain is calculated as follows:

Calculations

egin{align*} \text{Gross proceeds from sale} &= 100 \ times 10 = $1,000 \ \text{Cost of shares} &= 100 \times 6 = $600 \ \text{Total ACB} &= $600 + $17 = $617 \ \text{Net proceeds} &= $1,000 - $617 = $383 \ \text{Net gain after commission} &= $383 - $25 = $358 \ \text{Taxable capital gain} &= 0.5 \times $358 = $179 \end{align*}

Adjusted Cost Base of Additional Shares

Investors might own a number of the same class of shares bought at different times and different prices. When an investor owns identical shares bought at varying prices, the average cost method is used to calculate the adjusted cost base per share. The average cost per share is calculated by adding the cost base of all such stock and dividing by the number of shares held.

Example

Hugo bought 200 ABC common shares at $6 per share in January of last year, and 100 ABC common shares at $9 in June of this year. The new cost base for Hugo’s shares is the average cost of $7.15 per share, calculated as follows:

egin{align*} \text{Cost of 200 shares ($6 each)} &= 200 \times 6 + $25 = $1,225 \ \text{Cost of 100 shares ($9 each)} &= 100 \times 9 + $20 = $920 \ \text{Total cost base} &= $1,225 + $920 = $2,145 \ \text{Average cost per share} &= $2,145 / 300 = $7.15 \end{align*}

Adjusted Cost Base of Convertible Securities

When an investor exercises the conversion right attached to a security, the conversion is deemed not a disposition of property. Therefore, no capital gain or loss arises at the time of the conversion. The adjusted cost base of the new shares acquired is deemed that of the original convertible securities.

Example

A client buys 100 ABC preferred shares at a cost of $6,000. Each preferred share is convertible into five ABC common shares. Upon conversion, the client now holds 500 ABC common shares. The adjusted cost base per ABC common share is $12, calculated as follows:

egin{align*} \text{Adjusted cost base per preferred share} &= $60 \ \text{Number of common shares per preferred share} &= 5 \ \text{Adjusted cost base per common share} &= $60 / 5 = $12 \end{align*}

Adjusted Cost Base with Stock Dividends or Reinvestment Plans

Investors who receive stock dividends or who subscribe to Dividend Reinvestment Plans (DRIP) must declare the dividends as income in the year they are paid. Investors should keep a record of stock dividends and reinvestments because they increase the adjusted cost base of the investment. When the stocks are sold, the higher ACB will reduce any capital gain and may increase any capital loss.

Adjusted Cost Base with Warrants or Rights

Investors acquire warrants and rights through various methods:

  • Direct purchase in the market
  • Owning shares on which a rights offering is made
  • Purchasing a unit of securities (such as a bond with warrants attached)

Each acquisition method entails different tax treatments for exercising those rights or warrants.

Direct Purchase of Warrants and Rights

Exercising warrants and rights is not a disposition of property. The adjusted cost base of the securities, once exercised, is based on the total expenditure divided by the number of common shares owned.

Rights Received from Share Ownership

When an investor receives rights from owning shares, and then exercises those rights, the investor must calculate a new cost base for all common shares owned. This includes both the original and new shares acquired through rights exercise.

Unexercised Warrants or Rights

If warrants and rights are not exercised, they may be sold in the open market, or allowed to expire. For directly purchased warrants and rights, the capital loss equals the purchase cost plus any commission. If acquired at zero cost, no capital gain or loss is recognized.

Warrants and Rights Acquired for Free and Sold

If warrants and rights are received at zero cost and subsequently sold in the open market, the proceeds are considered a capital gain. The cost is zero, thus all profits are taxed as capital gains.


Key Takeaways

  • Capital Gains Calculation: Subtract the adjusted cost base and any sale-related expenses from the gross proceeds of sale.
  • Average Cost Method: Use this for same-class shares bought at different prices.
  • Convertible Securities: Adjusted cost base transfers from the original convertible security to the new shares.
  • Stock Dividends/Reinvestment Plans: Increase the adjusted cost base, potentially reducing capital gains upon sale.
  • Warrants and Rights: Different methods of acquisition affect their tax treatment; exercise and sales lead to different tax implications.

Glossary

  • Adjusted Cost Base (ACB): The original cost of an investment, including purchase price and related expenses, used for tax purposes.
  • Capital Gain/Loss: The profit/loss from the sale of an asset, calculated as the difference between the sale price and the adjusted cost base.
  • Dividend Reinvestment Plan (DRIP): A program allowing investors to reinvest dividends into additional shares of the company.
  • Warrants/Rights: Instruments giving holders the right to purchase shares at a set price before expiration.

Frequently Asked Questions (FAQs)

Q: How do I calculate the capital gain on the sale of shares? A: Subtract the adjusted cost base and related sale expenses (e.g., commissions) from the gross proceeds of the sale.

Q: What is the adjusted cost base (ACB)? A: It represents the investment’s cost for tax purposes, including the purchase price and any acquisition-related expenses.

Q: How does participation in DRIPs affect ACB? A: DRIPs increase the ACB of an investment, potentially reducing capital gains when the shares are sold.

Q: What tax implications arise from unexercised warrants? A: If unexercised warrants result in a capital loss equal to the purchase cost plus commissions, unless they were acquired at zero cost, in which case no capital gain or loss would apply.


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## What is the formula to determine a capital gain or loss from the disposition of shares? - [ ] Sale price multiplied by quantity minus initial purchase price - [x] Proceeds of sale minus the adjusted cost base - [ ] Total cost plus commission - [ ] Selling price minus purchase price > **Explanation:** The general rule is to subtract the adjusted cost base, which includes the original purchase cost and any pertinent commissions, from the proceeds of the sale to determine capital gain or loss. ## How do you calculate the adjusted cost base (ACB) for shares purchased? - [x] Original purchase price plus commission - [ ] Selling price minus commission - [ ] Quantity of shares multiplied by sale price - [ ] Net proceeds of sale minus initial investment > **Explanation:** The adjusted cost base includes the total cost of purchase plus the commission expenses. ## How are gross proceeds from a sale of shares calculated? - [ ] Selling price times number of shares minus commissions - [ ] Purchase price times number of shares - [x] Selling price times number of shares sold - [ ] Purchase price plus commission > **Explanation:** Gross proceeds are calculated by multiplying the selling price by the number of shares sold. ## If Hilde sells her shares for $1,000 with an initial investment cost of $617 including commission, the capital gain is? - [ ] $383 - [ ] $358 - [ ] $367 - [x] $379 > **Explanation:** Capital gain = Proceeds from sale ($1,000) - Adjusted cost base ($617) - Sales commission ($25) = $358. ## What is the taxable capital gain percentage in this context? - [ ] 40% - [ ] 45% - [ ] 60% - [x] 50% > **Explanation:** The taxable capital gain is typically 50% of the actual capital gain. ## How do you calculate the average cost per share when multiple shares are bought at different prices? - [ ] Sum of all purchase prices - [x] Total cost base of all shares divided by total number of shares - [ ] Average of all purchase prices - [ ] Highest purchase price divided by number of shares > **Explanation:** The average cost per share is calculated by adding the cost base of all shares and dividing by the total number of shares held. ## What happens to the adjusted cost base when stock dividends or reinvestment plans are involved? - [ ] It decreases - [x] It increases - [ ] It remains the same - [ ] It gets halved > **Explanation:** Stock dividends and reinvestments increase the adjusted cost base, as the dividends are declared and added to the investment. ## How is the new adjusted cost base calculated if an investor exercises rights received from direct share ownership? - [ ] It remains the same as the original shares - [ ] It is recalculated based on the market value at the time of exercising - [x] A new cost base is calculated for all common shares owned, including both the original and new shares - [ ] It is the initial purchase price plus exercised rights price > **Explanation:** When rights received from direct ownership are exercised, a new cost base is calculated for both original and new shares acquired. ## What is the adjusted cost base when an investor exercises conversion from preferred to common shares? - [ ] Market value of the preferred shares - [x] The adjusted cost base of the original preferred shares - [ ] Zero - [ ] Adjusted cost base of converted shares minus conversion price > **Explanation:** The adjusted cost base of the common shares is deemed to be that of the original convertible securities. ## What happens to warrants and rights that are received at zero cost and then sold in the market? - [ ] They are not taxed - [ ] They are taxed as ordinary income - [ ] They are added to the adjusted cost base - [x] All profits realized are taxed as capital gains > **Explanation:** Profits realized from selling warrants or rights received at zero cost are taxed as capital gains.

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Saturday, July 13, 2024