Today we have a guest post written by Mohamed Rizwan Bachani, the President & CEO of Unique Accounting Services. Thank you Mohamed for providing clarity on the new capital gains hike for our clients and followers!

Mohamed Rizwan Bachani
Unique Accounting Services
909 Simcoe St. N., Suite 200
Oshawa, ON
L1G 4W1
Tel: (905) 903-7669
Fax: 1-866-209-6945
Email: info@uniqueaccountingservices.ca
Web: www.uniqueaccountingservices.ca

The implications of the 2024 Federal Budget’s increase in the capital gains inclusion rate aresubstantial and will affect many more Canadians than originally contemplated.

The 2024 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. We will look into the specifics of these changes, their impact on different types of taxpayers, and outline strategic tax planning opportunities that could be advantageous before the new rules come into force.

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 realized a capital gain of $100,000, only $50,000 would currently form part of taxable income.

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 June 25, 2024. For businesses and trusts, this rate applies to all capital gains. However, individuals will retain the 50% inclusion rate on the first $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 ($100,000 total capital gain): $50,000 would be considered taxable income (50% of $100,000). As such, there is no change compared to the existing rules

Example 2 ($300,000 total capital gain): $158,333 would be considered taxable income (50% of $250,000 = $125,000 + 66.67% of $50,000 = $33,333). Hence, an additional $8,333 is added to taxable income compared to the existing rules (50% of $300,000 = $150,000)

Impact on Corporations and Trusts:

Example 1 ($100,000 total capital gain): $66,667 would be considered taxable income (66.67% of $100,000). Hence, an additional $16,667 is included in taxable income compared to the existing rules (50% of $100,000 = $50,000)

Example 2 ($300,000 capital gain): $200,000 would be considered taxable income (66.67% of $300,000). Hence, an additional $50,000 is included in taxable income compared to the existing rules (50% of $300,000 = $150,000)

Who Will Be Affected?

This change will predominantly impact:
1. High-income earners and affluent investors managing substantial capital gains
2. Business owners selling their shares for a significant gain
3. Corporations with investments in real estate, marketable securities and other capital assets
4. 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 June 25, 2024, there are several variables at play and customized professional advice is vital to maximizing your tax savings. Some potential options are listed below to consider.

1. Realizing Gains Before the Change

Realizing the sale of assets before June 25, 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 realized/unrealized capital losses, crystallizing a capital gain prior to June 25, 2024, becomes worth considering. This option may lead to cashflow issues as the tax needs to be paid without receiving any proceeds.

2. Strategic Use of Lifetime Capital Gains Exemptions

Maximizing use of the Lifetime Capital Gains Exemption (LCGE), which is increasing to $1.25 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.

3. 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.

4. Corporate Investing

Corporations might want to consider crystallizing gains prior to June 25th to enhance the corporation’s Capital Dividend Account which will otherwise be reduced from June 25th. 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 and take advantage of the lower capital gains inclusion rate on the first $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.

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.

Thanks again to Mohamed Rizwan Bachani, President & CEO of Unique Accounting Services for writing this guest post for us!