How does the 2024 capital gains inclusion rate increase impact you and your business?

UPDATE: On June 10th, the government released their Notice of Ways and Means motion to the House of Commons. Read the details of the announcement in our blog, here Capital Gains Inclusion Rate Increase: Update and Answers (achenhenderson.ca)

The 2024 Canadian federal Budget (“Budget 2024”) announced tax several measures that may impact our clients, most notably the increase in the capital gains inclusion rate from 50% to 67%. This blog will attempt to cover some of the implications of this announcement, however even though the changes are set to take effect on June 25, 2024, the government has yet to release legislation to review, or advise our clients on, before that date.

What is the capital gains inclusion rate?

A capital gain occurs when an individual or a corporation risks its capital by purchasing a capital property (machinery, a share of a corporation, real estate, etc…) and then subsequently sells it for more than they paid for it, resulting in a ‘capital gain.’

As of today, 50% of the capital gain is included in income and Budget 2024 proposes to raise that inclusion rate to 67% making the overall tax rate more in line with earning income from other sources such as dividends or employment income. While that might sound ‘fair’ and ‘equitable’ (preferred terms used by a Liberal government that has caused the most economic and social pain to Canada in several generations), there are many aspects of the government’s deployment of this policy which are horrendously unfair. More on this later.

Who is impacted by the capital gains inclusion rate increase?

Capital gains can be realized by anyone, including:

• “Wealthy” investors.
• Not wealthy investors.
• Corporations that hold capital property (investments, machinery, equipment, intellectual property, etc…).
  • This includes public corporations that earn capital gains, and then distribute their profits to Canadians via their investment portfolios and pensions.
• Owners of corporations, including small business owners (whether their company makes money or not – think plumbers and farmers), and shareholders of publicly traded companies.
• Anyone who owns a vacation property, inherited or otherwise. Millions of Canadians are in this situation.

Indirectly, everyone will be impacted by these proposals as it will make investment in Canada’s capital markets less attractive, and it will greatly reduce the rewards for risk takers and job creators like entrepreneurs, and investors. The people who are most impacted by this, the “ultra-wealthy,” have the means and motivation to move their capital to friendlier shores fairly quickly.

What are the proposed changes to the capital gains inclusion rate?

In summary:

• For individuals, the capital gains inclusion rate will apply as follows:
  • The first $250,000 (annually) capital gains individuals at 50%, the $250,000 exemption is reduced by:
    • Current year capital losses.
    • Previous year’s capital losses applied to the current year capital gains.
    • Exemptions claimed such as the LCGE, $10M employee ownership trust exemption or proposed Canadian entrepreneur’s incentive.
  • 67% thereafter.
• For corporations and trusts, the capital gains inclusion rate will increase from 50% to 67% on the first dollar of capital gain (no $250,000 exemption, as with individuals). This includes small business owners owned by people who are not ”ultra-wealthy”, simply because they took the risk of owning a corporation.
• Any capital gains realized on or before June 24, 2024, will be subject to the 50% gains inclusion rate.
• No grandfathering of unrealized capital gains which are accrued before June 25, 2024.

Read about the proposed lifetime capital gains exemption increase on June 25, 2024, from $1,016,836 to $1,250,000.

Read about the proposed Canada Entrepreneur’s Incentive.

When is the effective date of the increased capital gains inclusion rate?

June 25, 2024.

How does the capital gains inclusion increase unfairly impact entrepreneurs who own corporations?

There is no exemption on the first $250,000 of gains annually as there is with individuals who earn capital gains. In Alberta, if a business owner earns a $250,000 capital gain in their small business corporation, they will pay $25,875 (10.35%) more in tax than if they owned and sold the asset personally, this difference extends to $37,800 (15.12%) for a small business owner who lives in PEI.

Our tax system has a concept called integration which is a fairness concept which requires that income earned in a corporation and fully distributed to its shareholders should have the same amount of tax paid on it as if they had earned the income personally. This has been a bedrock in our tax system since the early 1970s. Integration isn’t perfect in any province as of today, but it is close.

The current proposals cause ‘disintegration.’ This ‘disintegration’ is unfair because a plumber or a farmer who has earned any capital gains in in their small business corporation will pay substantially more tax than a wealthy individual who earned the same capital gain outside a corporation if it is below $250,000/year.

Should I trigger capital gains before June 25, 2024, to save taxes?

There has been so much written in recent days about this topic, here’s a link to one of the better articles we’ve seen on the topic: Should I sell or should I hold? (cibc.com)

Unfortunately, as with so many things in tax, the answer is ‘it-depends.’ Every individual and corporation who is considering selling assets needs to run the numbers for their particular circumstance in order to know if they would get a tax advantage from selling shares before or after June 25, 2024.

There were changes in 2024 to the Alternative Minimum Tax which make this analysis incredibly complicated for investors, small business owners, job creators, cottage owners, and their tax advisers, and which can cause the tax savings to swing either way depending on their own particular facts and circumstances.

We have seen scenarios where the sale of a $2 million small business will attract less tax after June 25, 2024, where selling an investment portfolio will result in more tax after that date. The numbers change dramatically at $3 million. Donations change the math; Capital Dividend Account balances change the math. It is extremely complicated, particularly absent legislation and details from our government.

Why does it matter if there is no legislation yet?

Uncertainty, particularly in the realm of investing and creating jobs, is bad for business, and makes it impossible to predict the outcomes of tax policy announcements. There are several questions that tax advisers do not have answers to, making it impossible for us to properly advise our clients before June 25, 2024, including:

• Reserves? We do not know what the capital gains inclusion rate will be for individuals and corporations who sold assets and triggered capital gains before June 25, 2024, and are claiming reserves. For 2024 gains reserve income inclusions, will the amount be deemed to come in at the beginning or the end of the year or at some time after June 25, 2024? We presume any income included after June 24, 2024, will be at the new, increased rate and not grandfathered at the inclusion rate that was in place when the sale took place.
• Net Capital Loss Carry forward? We do not know how net capital loss carry forwards will be allocated and applied on capital gains earned before and after June 25, 2024.
• Election to trigger gain? Triggering gains without actually disposing of a property is an expensive endeavor that is not available, financially, to most middle-income Canadians. Will the government release a mechanism for average everyday Canadians to easily trigger gains without rushing to sell their stocks and vacation properties?
• Prorated exemption? The budget document indicates that the $250,000 exemption during 2024 and will not be prorated, so we presume the entire $250,000 will be available for capital gains realized between June 25, 2024 and December 31, 2024.
• Provincial tax? Alberta and Quebec administer their tax programs. Will they follow suit with the capital gains inclusion rate increase? How do we calculate provincial taxes?
• Back down? This federal Liberal government has an established history of backing down from its ill thought out legislative changes, sometimes at the very last minute. This started, most notably, with its 2017 attack on private company owners and their families, and extends to as recently as the last few months when it backed down from certain aspects of its UHT fiasco, and the ill-conceived Trust reporting rules at the very last minute – well after clients and the tax community had committed an estimated $1 billion to complying with the new rules.
• Trust allocations? Under our current laws, trust allocations are deemed to take place on December 31, even if the capital gain being allocated to the beneficiary took place in the trust prior to June 25, 2024.
• Implementation date? Will the June 25, 2024, implementation date stick? It is entirely possible that the government will delay the implementation date to December 31, 2024 (or later), to give taxpayers some time to review the legislation and apply it to their situation?
• $250,000 exemption for corporations? Will corporations, such as Canadian Controlled Private Corporations, get the same treatments as the individuals who own them and be entitled to the $250,000 exemption to fix ‘disintegration’.
• Change of government? Will the next government scrap these rules altogether?
• Trust and Estates? We do not yet know if the $250,000 exemption will apply to Graduated Rate Estates, or taxpayers on death, alter-ego trusts, and joint spousal trusts.
• Grandfathering? Will there be any grandfathering for gains accrued but not realized before June 25, 2024?
• Is this just the beginning? Will the government attempt to further increase the capital gains inclusion rate in the future?

These are just some of the uncertainties which make it impossible for tax advisers to advise their clients prior to the proposed implementation date of June 25, 2024, on whether to trigger their capital gains.

What are some of the suggestions on how to fix this mess?

The Joint Committee on Taxation, made up of CPA Canada and the Canadian Bar Association, sent their recommendations to the government relating to the proposed capital gains inclusion rate increase.

They include (summarized in my own words), among other things:

• Allow taxpayers a straightforward way to trigger gains on their properties without actually rushing to dispose of them by June 24, 2024, or incurring significant professional fees to trigger a gain through the existing tools in the income tax act.
• Extend the transition date to December 31, 2024, as this would give taxpayers a chance to do proper planning, and it would have no impact on government revenues in 2024.
• Allow grandfathering for certain transactions entered into by a certain date with a planned closing after June 25, 2024.
• Change the legislation to prevent retroactive effects on a number of transactions that were entered into before June 25, 2024, but which extend out past that date, such as trust transactions, capital gains reserves, stock options, amongst others.
• Fix disintegration. It is simply not fair that a corporation would have to pay 10-15% more in tax on a capital gain than an individual.
• Deal with various Trust taxation issues like the problems caused for Graduated Rate Estates, Qualified Disability Trusts and Henson Trusts, and Alter Ego or Join Spousal trusts.

What is the status of the capital gains inclusion rate increase legislation?

The Canadian tax community at large has been expecting an increase to the capital gains inclusion rate for the last several federal budgets and has been somewhat shocked when successive budgets were presented absent the change. Unfortunately, 2024, which could be the last budget that this government brings forward if an early election is triggered, is the year that these changes are announced and set to tax effect.

• April 16, 2024: When most tax professionals are busy working through the 2023 tax season, the Liberal Government presents budget 2024, billing as it a “Fairness for every generation” budget.

We take issue with this political spin, as you have learned this budget is not about fairness, but rather about raising revenues for a reckless spendthrift government. I am confident in suggesting that this is the most impactful change to tax policy since I have been in practice (nearly 20 years).

• May 2, 2024: The government presents the budget bill C-69 to the house for first reading.

The 686-page legislation document is, notably, lacking any details, or anything whatever, about the proposed capital gains inclusion rate increase, despite the effective date of the legislation being only 7.5 weeks from May 2, 2024. This is a massive problem for a vast number of Canadians, and their advisers, who must decide whether they should proactively trigger capital gains at the existing gains inclusion rates, presumably prior to the release of the relevant legislation.

While tax advisers can “guess” the various outcomes of the April 16^th announcement, it is virtually impossible for us to provide solid advice to our clients about whether to trigger gains before June 25, 2024, absent actual legislation.

This creates ‘chaos’ and ‘uncertainty,’ not ‘fairness’ and ‘equality,’ for private company owners, job creators, and investors, and will certainly add to Canada’s economic woes. Uncertainty such as this leads investors to look to friendlier shores.

Why does the government want to raise the capital gains inclusion rate?

The most obvious reason is that the government is in desperate need of revenue due to 9 years of reckless deficit spending. The government is expecting a nearly $5 billion tax windfall in 2024.

The stated, and mathematical, reason for the increase is to even out the perceived advantage that risk takers and job creators get via capital gains when compared to lower risk dividends and regular (employment and other) income. PM Trudeau has been saying (over and over and over again), it’s a way to ensure “inter-generational fairness”.

Notwithstanding the government spin, which is false and obviously misleading, the government’s own budget shows that this is effectively a wealth tax that will be triggered in just a couple of weeks. While the stated target of these proposals are the so-called “ultra-wealthy” and “rich,” I have demonstrated how they impact small business owners on their first dollar of capital gain while giving the “ultra-wealthy” a $250,000 (per family member per year) advantage, proving that the government’s stated objective is, once again, misleading spin.

What should I do next?

It is especially important to understand the impact of the capital gains inclusion rate increase on your circumstance. Reach out to your tax adviser if you have unrealized gains in your corporation or personally and ask them to run the numbers based on the limited information we have today. While they will likely not be able to offer solid advice at this point, you will be better equipped to plan as to whether to trigger your capital gains before or after June 25, 2024.

Would you like to discuss how the capital gains inclusion rate might impact you and your business? We would love to discuss your business and your tax saving opportunities.