Introduction
On April 16th the Department of Finance released Budget 2024: Fairness for Every Generation ("Budget"). This new budget introduces a generational tax increase that affects lifelong tax planning rates for many Canadians. The release of the Budget has caused many Canadians to ask questions surrounding the proposed capital gains inclusion rate and how they may be affected by it.
New Inclusion Rate On Capital Gains
The budget proposes to increase the capital gains inclusion rate. Previously, Canadians only paid tax on 50 percent of capital gains, which is the gain which results from selling capital property (such as a stock) for more than its cost. Capital gains taxation was introduced as part of tax reform in 1972, and until 1988 was applied at 50%. The rate increased to 66.67% in 1988 and to 75% in 1990. The rate started to decline in February 2000, down to two thirds until October 2000, where it was dropped back to 50%, where it has remained unchanged until this budget. The Budget increases the amount of the capital gain inclusion rate to two-thirds if you have over $250,000 in gains throughout the year.
This change is justified as a way for the government to tax the wealthiest Canadians at a higher rate, while attempting to maintain the same 50 percent inclusion rate for everyone else. This change will have a large impact which may cause an increase in tax on death for individuals, reduce after-tax returns to investors, and increase tax burden on professionals whose retirement savings are tied up in capital property. Additionally, the employee stock option deduction will be reduced to reflect this higher inclusion rate.
Who Does Finance Consider Wealthy?
This higher inclusion rate is not going to affect all Canadians. The increased rate is purported to be targeted at the wealthiest Canadians, corporations, and trusts. The increased rate will only apply to individuals with over $250,000 in capital gains in a year. Finance projects that over 99% of Canadians will be unaffected by this change. The Canadian Medical Association (CMA) criticized the proposal along with other business leaders and is asking the Liberals to reconsider as the change will impact doctors' retirement savings as most incorporate and operate their practice as a small business. It's this kind of potential for "collateral damage" that Canada's Parliamentary Budget Officer Yves Giroux voiced caution about in an interview on CTV News Channel's Power Play.
Citing the sale of secondary residences such as cottages or rental properties in the current housing market as examples of how Canadians could feel the impact of this tax change, Giroux said it's not unusual for capital gains to be realized "well in excess of $250,000."
"The moment you have a capital gain that's higher than a quarter million, then you're captured by that higher capital gains inclusion rate," he said.
Finance also states in the Budget news release that Canadians will still continue to benefit from TFSAs, the principal residence exemption, and registered pension plans. These are the most common ways the average Canadian will realize a capital gain and the proposed changes should avoid an increased tax burden on these benefits. However, despite the framing of these changes in the Finance news release, cottages classify as capital property and will also be subject to the new inclusion rate if the capital gain realized brings that individual over the $250,000 threshold for the year.
Potential Relief From Higher Inclusion rates: LCGE and CEI
Although poised to target the wealthy these new changes leave questions regarding how those without registered savings plans will be affected. Aside from the wealthy, the new inclusion rate may adversely affect entrepreneurs and professionals who choose to reinvest profits into their businesses rather than save them in registered savings plans. To offset this problem the proposal also includes a 25 percent increase in the Lifetime Capital Gains Exemption ("LCGE") from $1,016,836 to $1,250,000. This exemption applies for disposition of qualified small business corporation shares, and the increase is meant to offset the negative impact the new inclusion rate may have on such dispositions.
Additionally, the government is proposing a new Canadian Entrepreneurs' Incentive ("CEI"), which will reduce the capital gain inclusion rate to 33.3 percent up to $2 million in eligible capital gains. This incentive is meant to offset the potential capture of those who opt for reinvestment over remuneration and instead accumulate sweat equity. The incentive applies to founding investors in certain sectors who own at least 10 percent of shares in their business, and where the company has been their principal place of employment for the last five years.
Finally, the net capital losses which are generated from the previous 50 percent rate will continue to be deductible against taxable capital gains but will be adjusted to reflect the inclusion rate of the capital gains being offset. This allows for previously incurred losses which are realized prior to this change to fully offset an equivalent capital gain after this rate change.
Pro Tax Tips – The Timing Of Disposing A Capital Property Is Important
When deciding on whether or not to sell a capital property there can be important tax implications that arise depending on the timing of the disposition. This can take form of legislative change such as the increased inclusion rate on capital gains, or simply from how other provisions in the act may change the treatment of your gain or loss for tax purposes. Timing is important, meaning that before you decide to sell you should make sure you know if there may be any tax implications which could vary depending on the time of disposition.
If you are uncertain how this new change will affect you or your business, you should engage with one of our expert income tax lawyers. Our expert Canadian tax lawyers can provide legal advice and assist you with fighting unreasonable CRA decisions.
FAQ
What Is A Capital Gain?
A capital gain or will occur after the disposition of a capital property some time during the taxation year for an amount greater than the cost of the property. A capital property is a property which you purchase for investment purposes or to earn income. Capital property does not include trading assets of a business such as inventory. Examples of a capital property include: cottages, shares, bonds, crypto assets (if they are not being regularly traded) land, buildings, and equipment. A disposition occurs when you give up possession and ownership of a property (such as in a sale), or when the tax system considers a property to be disposed of (even though you did not actually sell it) such as when it is gifted or upon death.
Will I Have To Pay More Tax As A Result Of This Increase?
For many Canadians including those who have invested the majority of their retirement savings into capital properties directly, or who own a cottage property, the new inclusion rate will result in a larger tax liability than was previously required upon disposition.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.