The capital gains inclusion rate is changing in Canada. The federal government proposed changes to Capital gains inclusion in Budget 2024 on April 16, 2024.
Important Information: Please note that the information presented in this article refers to the proposed changes from Supplementary information from the Budget 2024. Legislation detailing the implementation of these measures is expected in the coming months.
Further, the readers should exercise an extreme caution while attempting to undertake the potential planning opportunities outlined below. These income tax planning opportunities involve complex tax issues and you must consult your professional income tax accountant before making any decision.
Updated on May 1, 2024
What are the Changes?
This is important to mention that it is the inlcusion rate that is changing, not the tax rate as widely misreported on various news articles.
Currently, the capital gains inclusion rate in Canada is 50% (one-half) whether the taxpayer is an individual or a corporation. This is changing now.
For the capital gains realized after June 25, 2024:
- Corporations and Trusts will have a two-thirds inclusion rate for all the capital gains realized.
- Individuals will have two thirds inclusion rate for capital gains that exceed $250,000.
For individuals $250,000 threshold would be applicable to capital gains realized, directly or indirectly through a partnership or a trust, and net off:
- net off prior year capital losses,
- current year capital losses, and
- capital gains for which any of the below is claimed
- Lifetime Capital Gain Exemption
- Employee Ownership Trust Exemption, or
- Canadian Entrepreneur’s Incentive
Employee stock option that currently provides a one-half deduction would be changed to one-third where combined employee stock options and capital gains exceed $250,000.
The capital losses of prior years would be adjusted to reflect the inclusion rate so that capital loss realized before the changes can fully offset capital gains after the changes.
In 2024, for individuals, $250,000 threshold would be fully available (not pro-rated) and apply to the net capital gains realized after the rate change.
Though the transitional rules will come in the coming months, however, the tax years starting after June 25, 2024, two different inclusions rates will apply.
What are the effects?
- Professional corporations such as Medical professional corporations, law firms, or accounting firms where excess retained earnings are invested in passive assets.
- Holding corporations that invest in passive assets and generate portfolio income
- Sale of real estate properties that do not meet the principal residence exemption
- Emigrants with Deemed disposition of assets at departure from Canada
- Employees who are paid by employee stock options will have higher inclusion where a combined limit of $250,000 is exceeded.
- Capital reserves for the sales contracts entered before June 25, 2024, where portion of the capital gains are going to be realized in the future years.
- Lifetime Capital Gains Exemptions is proposed to increase $1.25 million.
- A brand new Canadian Entrepreneurs’ Incentive, that is in addition to the existing Lifetime Capital Gain Exemption
Some Planning Opportunities
The capital gain inclusion rate was proposed on April 16, 2024, for a rate change that will take effect on June 25, 2024. Until now there is not much clarity on many issues involved here.
Still, there are a few planning opportunities available.
Transfer to Corporations – Crystallization of Accrued Capital Gains
Section 85(1) rollovers can allow crystallization of Capital gains.
Section 85(1) of the Canadian Income Tax Act allows for a tax-deferred transfer of eligible property, from a taxpayer to a taxable Canadian corporation. This is commonly referred to as a “rollover.” The rollover is beneficial for deferring the recognition of income or gains associated with the transferred property until a future date, typically when the taxpayer disposes of the shares received in exchange for the property.
While filing this election, both taxpayer parties can elect to deem an amount, up to the Fair market value of the property transferred, as proceeds of disposition. By electing an amount the accrued capital gains can be crystallized and realized before the rate change.
Since it involves legal ownership changes, it is possible to undertake this transaction before June 25, 2024, and the decision related to the elected amount be made after that date.
Share Exchange
Share exchanges under Sections 51 and 86 are tax-deferred.
Section 51 allows shareholders to exchange their shares or convertible securities for new shares of a different class in the same corporation without recognizing a taxable gain, provided no other form of consideration (known as boot) is received. It’s often used when shareholders want to convert debt to equity or reorganize share classes for purposes such as simplifying the capital structure.
Section 86 facilitates a tax-deferred exchange where shareholders can reorganize their holdings by swapping all shares of one class for shares of a different class within the same corporation. This is particularly useful for estate freezes or restructurings aimed at introducing new shareholders or altering voting rights. Section 86 requires that the shareholder dispose of all shares of a particular class, and the corporation must amend its articles of incorporation as part of the process.
Both Section 51 and 86 allow tax-deferred share exchanges. However, a carefully crafted share exchange agreement while making section 85(1) election can avoid sections 51 and 86, hence, realizing the capital gains.
Transfer to a Canadian Partnership – Subsection 97(2)
Transfer of assets to a Canadian Partnership is a fully taxable transaction. Similar to transfer to corporations, there is a planning opportunity to make a joint election to realize Capital gains.
Using Carryforward Balances of Net Capital Losses
Both crystallization and share exchanges will result in an immediate cash outflow. When capital gains are realized, even at a lower inclusion rate, will require payment of tax dollars.
Another planning opportunity can be to hold on to the net Capital losses so that they can be applied to the capital gains at higher inclusion rate.
Final Word
Depending on your situation there might be other opportunities available. As this is an evolving topic, we are expecting more clarity and details in coming days. If you are undertaking any transactions to realize capital gains now, be mindful of transaction costs, immediate income tax liability, and opportunity costs involved.
