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Proposed changes to capital gains inclusion rate

Wondering how the proposal could impact your financial situation?

Since being announced in the 2024 federal budget, the increase to the capital gains inclusion rate effective after June 25, 2024 has attracted significant public attention. Draft legislation for the proposal was finally released on June 10, 2024, and it’s not much different from the initial announcement.

Now that draft legislation is available, here’s what you need to know.

What is the capital gains inclusion rate?

Essentially, you have a capital gain if you sell an asset for more than it cost you to buy it. If the opposite occurs, the result is a capital loss.

For income tax purposes, dispositions that trigger capital gains and losses can be actual or deemed. For example, if you gift an asset to another person, it’s considered a deemed disposition, and you would report a capital gain or loss, even though you aren’t actually receiving proceeds.

When reporting capital gains and losses on your income tax return, an inclusion rate is applied to reflect the amount that is actually taxable (or allowable in the case of capital losses). Your tax rate would then be applied on your net taxable capital gains to determine your tax liability.

Example:
You realize a capital gain of $400,000. If the applicable inclusion rate is 50%, you would only report a taxable capital gain of $200,000 on your income tax return. If you reside in Nova Scotia and pay tax at the top rate of 54%, the associated tax liability would be $108,000.

How is the capital gains inclusion rate changing?

Here’s how the changes apply to capital gains and losses realized on or after June 25, 2024:

Type of taxpayer	Inclusion rate before June 25, 2024	Inclusion rate(s) on or after June 25, 2024
Individuals, graduated rate estates, and qualified disability trusts	50% on all capital gains and losses	50% for the first $250,000 of net capital gains realized in the year; and 66.67% for net capital gains realized in the year exceeding $250,000
Corporations		66.67% on all capital gains and losses
All other trusts		66.67% on all capital gains and losses

Example:
In the same scenario of a $400,000 capital gain, you would report a taxable capital gain of $225,000 (50% inclusion rate on the first $250,000, 66.67% on the remaining $150,000), attracting a tax liability of $121,500.

What else should you know?

The draft legislation also clarifies the following:

The principal residence exemption would be maintained, allowing individuals to claim a full or partial exemption on capital gains realized on their principal residence.
No tax elections would be permitted to trigger capital gains without an actual transfer of property.
The $250,000 annual threshold for the 50% inclusion rate available to individuals is a “use-it-or-lose-it” amount – unless a reserve is available, capital gains realized cannot be averaged over multiple years to stay under the threshold.
Individuals cannot share their $250,000 annual threshold with their corporations or trusts.
No specific assets, corporations, or sectors will be exempt from the 66.67% inclusion rate.
No “grandfathering” of the 50% inclusion rate on capital gains accrued but not realized before June 25, 2024, will be permitted.

Who could be impacted?

Here are some scenarios that could be negatively impacted under the proposal:

Individuals gifting secondary property to children.

Real estate values have appreciated over time, and accrued capital gains on a property could easily exceed $250,000. If the principal residence exemption is not an option for you on a gift of a secondary property, you could pay more tax under the proposal than under the old rules.

Professionals and business owners who have incorporated as a way to accumulate retirement savings.

The increase in the inclusion rate from the first dollar of capital gains realized by corporations will have a number of implications, including:

Increased integrated tax cost on capital gains. For example, a professional in British Columbia would pay a top tax rate of 26.75% on the first $250,000 of capital gains realized personally, but would pay an effective tax rate of 39.40% if the same gains were realized in their corporation and then distributed as a dividend (a 47% increase in tax).
Decreased additions to the corporation’s “capital dividend account” resulting in less tax-free amounts that can be distributed by the corporation to Canadian-resident shareholders.
Reduced tax deferral advantage on small business income due to passive income rules, which take into account capital gains subject to the higher inclusion rate.

Individuals selling shares of a qualifying small business or farm or fishing properties.

While the 2024 budget proposes an enhanced lifetime capital gains exemption (LCGE) of up to $1,250,000 on capital gains realized from sales of such assets, gains in excess of the LCGE claimed are now exposed to the tiered inclusion rates.

Example:
If you live in Ontario and realize a capital gain of $4,000,000 from the sale of shares of a qualifying small business, your tax liability (after claiming your LCGE) would be $959,100 under the proposal, versus $798,400 under the old rules.

Planning tips

Here are some tips to help you navigate the complexity of capital gains taxation:

1. Get tax advice first.

It’s easy to rush into a sale or transfer of assets based solely on potential tax savings. Don’t let the “tax tail wag the investment dog.” This is a good opportunity to connect with your professional tax advisors to review your situation, perform calculations, and figure out if you should take any actions. Tax planning for 2024 is particularly important because this is a “transition year” where two different inclusion rates could apply.

2. Work with us to help you stay the course in your investment strategy in a way that remains tax efficient.

3. Revisit your estate plan.

We can help you review your estate plan and reassess your tax liability on death, taking into account the higher inclusion rate. We’ll address questions like: Will you still have sufficient liquidity in your estate (including any life insurance proceeds) to fund the liability? Will your distribution plan to beneficiaries remain as intended? The answers to these questions may mean you’ll need to make adjustments to your estate and insurance planning.

4. Review your asset ownership mix.

If you’ve accumulated investments in your corporation, traditional tax planning has often favoured keeping investments in the corporations if you don’t need them personally. However, the changes may make it more compelling from a tax perspective to hold some investments personally rather than through a corporation so that you can benefit from the tiered inclusion rates.

5. Consider other wealth-building opportunities within your corporation.

If you are an incorporated business owner or professional, you should explore other opportunities to shift what would otherwise be taxable assets into tax-preferential vehicles, like:

An individual pension plan
Corporate life insurance

6. Donate qualifying capital property with accrued capital gains.

Donating qualifying capital property, such as publicly listed securities, to charities can still be a tax-efficient giving strategy, because accrued capital gains on such properties are exempt from tax. But be sure to get tax advice on any “alternative minimum tax” implications of this strategy.

Talk to us.

We’ll help you work through these proposed changes and understand how they impact your financial situation.