How your investments are taxed

Many Canadians defer or are exempt from paying taxes on their investments by using RRSPs and TFSAs to facilitate their retirement savings, but it is still important to recognize how your income from investments is potentially taxed in Canada.

After all, it’s often the case that some portion of your investment savings will fall outside of these two tax-advantaged vehicles with income that is earned subject to taxation at the time it is realized. 

Investors should be aware that there are three main types of investment income, all of which are taxed in significantly varying ways. Let’s take a closer look:

Interest income

Interest income is earned by depositing or lending money to others. Interest can be earned on investments such as guaranteed investment certificates (GICs), income payments from government or corporate bonds or T-bills, certain mutual funds, etc.

Interest income is normally taxable at the individual’s marginal tax rates. These rates can be in excess of 50% for the highest income earners in some provinces. In order to avoid a tax deferral when earning interest on certain investments (for example GICs exceeding one year that may not pay until maturity), it is usually taxed on an accrual basis. Generally, this interest is subject to tax on a 12 month cycle from the date the investment is purchased.

Dividend income

Individuals that invest in shares of corporations, either directly or through a mutual fund or ETF which holds shares, can earn dividends. These dividends represent the distribution of corporate profits to the shareholders.

Recognizing that corporations already pay income tax on the profits they earn, dividends paid to shareholders can receive favourable tax treatment. This is achieved through a dividend gross up and dividend tax credit for individuals.

Capital gains

Capital gains represent the growth or increase in value realized on the sale of a capital asset such as a stock, a bond or real estate. Only half of the gain realized on the disposition of a capital asset is subject to tax.

Where the value of a capital asset declines and a loss is realized on the sale of the asset, a capital loss arises. Such capital losses may be used to offset capital gains realized. If the allowable capital losses for the year exceed the taxable capital gains, the excess losses may be carried back three years and applied against net taxable capital gains for those preceding years. Alternatively, they may be carried forward indefinitely to apply against future capital gains.