Navigating the 2024 Canadian Federal Budget capital gains inclusion rate increase
Vinay Khosla
by Vinay Khosla
The implications of the 2024 Canadian Federal Budget's increase in the capital gains inclusion rate are substantial and will affect many more Canadians than originally contemplated.
The 2024 Canadian Federal Budget has proposed significant changes to the capital gains inclusion rate, a move that has potentially significant tax and financial planning implications for taxpayers, especially those involved in recurring or singular high-value transactions. This article delves into the specifics of these changes, their impact on different types of taxpayers, and outlines strategic tax planning opportunities that could be advantageous before the new rules come into force.
Understanding the capital gains inclusion rate
The capital gains inclusion rate is not a direct tax. However, it determines how much of a capital gain must be included in a taxpayer’s taxable income. Since 2000, the rate has been set at 50%. For example, if an individual realised a capital gain of CAD 100,000, only CAD 50,000 would currently form part of taxable income.
2024 Budget changes to the inclusion rate
The 2024 Federal Budget has proposed to increase the inclusion rate from 50% to 66.7% for dispositions of capital property occurring on or after 25 June 2024. For businesses and trusts, this rate applies to all capital gains. However, individuals will retain the 50% inclusion rate on the first CAD 250,000 of capital gains per year. This change means a greater portion of capital gains will be taxable, effectively raising the tax burden on investments.
Consider the following examples:
Impact on individuals:
Example 1 – CAD 100,000 total capital gain: CAD 50,000 would be considered taxable income (50% of CAD 100,000). As such, there is no change compared to the existing rules.
Example 2 – CAD 300,000 total capital gain: CAD 158,333 would be considered taxable income (50% of CAD 250,000 = CAD125,000 + 66.67% of CAD 50,000 = CAD 33,333). Hence, an additional CAD 8,333 is added to taxable income compared to the existing rules (50% of CAD 300,000 = CAD 150,000).
Impact on corporations and trusts:
Example 1 – CAD 100,000 total capital gain: CAD 66,667 would be considered taxable income (66.67% of CAD100,000). Hence, an additional CAD 16,667 is included in taxable income compared to the existing rules (50% of CAD 100,000 = CAD 50,000).
Example 2 ($300,000 capital gain): CAD 200,000 would be considered taxable income (66.67% of CAD 300,000). Hence, an additional CAD 50,000 is included in taxable income compared to the existing rules (50% of CAD 300,000 = CAD 150,000)
Who will be affected?
This change will predominantly impact:
High-income earners and affluent investors managing substantial capital gains;
Business owners selling their shares for a significant gain;
Corporations with investments in real estate, marketable securities; and other capital assets; and
Estate inheritances where sizable capital gains are a factor.
Tax planning opportunities
While it may seem like the simplest solution would be to incur capital gains prior to the proposed effective date of 25 June 2024, there are several variables at play, and customised professional advice is vital to maximising your tax savings. Some potential options are listed below to consider.
Realising gains before the change
Realising the sale of assets before 25 June 2024 allows individuals and corporations to benefit from the current lower inclusion rate. Some potential pitfalls to this strategy include triggering alternative minimum tax. If selling residential real estate, properties held less than one year may be subject to the residential property flipping rule resulting in 100% of the gain being included as taxable income.
If a taxpayer has realised / unrealised capital losses, crystallising a capital gain prior to 25 June 2024 becomes worth considering. This option may lead to cashflow issues as the tax must be paid without receiving any proceeds.
Strategic use of lifetime capital gains exemptions
Maximising use of the Lifetime Capital Gains Exemption (LCGE), which is increasing to USD1.25 million, can significantly reduce taxable gains from the sale of qualified small business corporation shares and similar assets. Involving a family trust in the share ownership should be considered to potentially multiply the LCGE.
Revisiting estate and succession plans
With higher future taxation on gains, revising estate and succession plans to incorporate these changes is crucial, potentially involving earlier transfers or restructuring of asset ownership. Life insurance planning to account for increased capital gains taxation on the death of a shareholder should also be reviewed.
Corporate investing
Corporations might want to consider crystallisation of gains prior to 25 June 2024 to enhance the corporation’s capital dividend account (CDA) which will otherwise be reduced from 25 June. The CDA represents the non-taxable portion of a corporate capital gain that can be extracted from the company tax-free. The cash obtained by the individual shareholder can then be invested in capital property, taking advantage of the lower capital gains inclusion rate on the first CAD 250,000 of annual capital gains which would not otherwise be available at the corporate level.
Also, consider investing in certain corporate class mutual funds that are structured to defer capital gains and provide for cash flow in the form of tax-free return of capital prior to their disposition. Corporate owned permanent life insurance with an investment component also serves to provide estate planning combined with tax free appreciation.
Emigration from Canada
If a taxpayer emigrates from Canada, there is a deemed disposition of all capital property on the date they ceases to be a Canadian tax resident. If an individual is planning to emigrate and has unrealised capital gains in excess of CAD 250,000, the timing to cease tax residency should be reviewed. Consideration should be given to accelerate the cessation of Canadian tax residency prior to 25 June 2024. Alternatively, crystallising capital gains prior to 25 June 2024, should also be reviewed.
Conclusion
The upcoming increase in the capital gains inclusion rate presents both challenges and opportunities. Taxpayers, particularly those with potential high-value sales of capital property, should consult with their tax advisors to assess the best strategies in light of these changes
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With more than 20 years of experience in Tax Planning and Optimization, Vinay Khosla is a pragmatic and business-minded specialist who employs the highest level of tax knowledge. With careful attention to detail, he finds innovative, value-added solutions that ensure his clients reach their personal and professional goals. His holistic approach and strong values are what set him apart from competitors.Contact Vinay.
