How your total income is calculated
Income for tax purposes
Section 3 sets out the order of operations for computing a person's income for a year: employment, business, property, then capital gains, then other sources, minus allowable losses.
Plain-language explanation
Section 3 is the master formula for calculating your income. It works in a specific order that affects how losses interact with income.
Step 1 — Positive income sources (s.3(a)): Add up income from employment (s.5–8), business/property (s.9–37), and other positive amounts included by other parts of the Act. These are always positive — you cannot reduce this pool below zero with these sources' own losses.
Step 2 — Net capital gains (s.3(b)): Calculate your net taxable capital gains (gains minus losses, then ×50%). This is separate because capital losses can only be applied against capital gains, not against other income (s.3(b) can go to zero but not below).
Step 3 — Other deductions (s.3(c)): Subtract amounts deductible under s.60 and other provisions — RRSP contributions, support payments, moving expenses, union dues, etc.
Step 4 — Losses (s.3(d)): Subtract allowable business investment losses (ABILs) and net capital losses from other years if applied.
The result is your "income for the year" from which taxable income is derived. Understanding the stacking order matters for loss-planning — capital losses can't shelter employment income.
Example
Priya has: employment income $80,000, rental loss ($5,000), capital gain $20,000 (taxable: $10,000). Step 1: $80,000. Step 2: $10,000 net capital gain. Step 3 minus rental loss: $80,000 − $5,000 = $75,000 (rental loss is a business/property loss that offsets other income). Total income: $75,000 + $10,000 = $85,000.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Capital gains inclusion rate reduced from 100% to 66.67%, then to 75% (1990–1999), then to 50% (2000–). The s.3(b) net-capital-gains computation changed to reflect the new taxable fraction.
Before
Capital gains fully included in income (100% inclusion)
After
50% inclusion rate from 2000 forward; only net taxable capital gains flow through s.3(b)
Inclusion rate settled at 50% following prior reductions. S.3(b) computation stabilized — net capital gains at 50% inclusion rate.
Before
75% capital gains inclusion (1990–1999)
After
50% capital gains inclusion from 2000 onward
Common questions
Can capital losses reduce my employment income? +
No. Capital losses can only offset capital gains. If your capital losses exceed your capital gains in a year, the excess is a net capital loss that can be carried back 3 years or forward indefinitely — but only against capital gains, not employment or business income.
Can a rental loss reduce my employment income? +
Yes, generally. A rental loss (from actual rental activity, not a tax shelter) is a business/property loss under s.3(d) that can offset employment or other income in the same year.
What is the difference between income and taxable income? +
Income is calculated under s.3. Taxable income is lower — it is income minus deductions under Division C (ss.110–114.2), such as the capital gains exemption, loss carryovers, and the lifetime capital gains exemption.
Key terms
Related sections
Related calculators
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 3. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.