The 2024 federal budget is going to bring the long-discussed increase in the capital gain (“CG”) inclusion rate to life, effective June 25, 2024, if enacted. This is a major change from the 50% inclusion rate since 2001. The proposed changes are listed as follows:
Taxpayer | Before 2024-06-25 | Effective 2024-06-25, if enacted |
Individuals | 50% inclusion rate | First $250,000 of CG – 50% inclusion rate; >$250,000 of CG – 2/3 inclusion rate |
Corporations | 50% inclusion rate; 50% Capital Dividend A/C (“CDA”) addition | 2/3 inclusion rate; 1/3 CDA addition |
Trusts | 50% inclusion rate | 2/3 inclusion rate |
Lifetime capital gain exemption on disposition of Qualified Small Business Corporation (“QSBC”) shares, qualified farm or fishing property - increase to $1.25 million, effective June 25, 2024;
Canadian Entrepreneurs’ Incentive (CEI) – reduced 1/3 inclusion rate on $2 million of lifetime eligible capital gain realized on disposition of QSBC shares by founders that meet certain conditions, with $200,000 addition each year, phase-in over 10 years, effective in 2025. The founders should own at least 10% of the corporate shares, and the company has been their principal employment for at least five years.
We will look into details how individuals and corporations are affected by such proposed changes and what could be done, if enacted, to reduce the impact of the higher CG inclusion rate or utilize the advantage of increased lifetime CG exemption and CEI.
Individuals:
Impact:
Only taxpayers with realized capital gain over the annual limit of $250,000 will be affected;
For 2024, taxpayers are required to track capital gains realized before and after June 25, 2024. The $250,000 annual limit for 2024 is not prorated for the period from June 25, 2024;
Individuals who have built up significant unrealized CG over lifetime, including shares of private companies, will be faced higher tax rates upon death due to the deemed disposition at market value rule.
Without proper estate planning and post-mortem tax strategies, the double taxation upon death of corporate owners may trigger stunningly high tax, in some cases up to 83% in the highest tax bracket, unless CRA releases more detailed rules to eliminate or reduce this unfairness to business owners.
Business owners selling QSBC shares will have chance to benefit from at least $3.25 million in total lifetime capital gains exemptions and reduced inclusion rate.
Illustrations:
The following example shows the tax payable and after-tax cash flow on $1 million of capital gain realized by an individual in 2023, in 2024 (assume $500k realized before the tax change and $500k realized after the tax change) and in 2025.
Assume that taxpayer is in the highest tax bracket and there is no change in tax rates over the three years, the taxpayer will pay $22k more tax in 2024 and $67k more tax from 2025.
An individual accumulated 3 million of unrealized capital gains on capital properties upon death. The capital properties are deemed to have been disposed at market value.
The following example shows the tax payable of a business owner upon death owning corporate shares worth $1 mil at fair market value, without estate planning and post-mortem tax strategies, with comparison before and after the proposed tax change.
Planning Opportunities, assuming the budget is enacted:
Sell off investments with large unrealized capital gains before June 25, 2024, and if preferred, buy back. This will be especially more tax-effective for those who have short life expectancy. Note that for sale of marketable securities, due to the settlement date being 1 business day after the trade date, the trading needs to happen by June 21, 2024 in order to take the advantage from this planning. For sale of real properties, the closing day has to be prior to June 25, 2024.
Transfer partial or full title of investments with highest unrealized capital gains to a related party prior to June 25, 2024 with capital gains realized at current market value. The same value becomes the cost of the related party.
Schedule the disposition of investments by limiting realized capital gains within $250,000 per year;
In the year of realizing large capital gain, e.g. on sale of a real property, sell off investments with unrealized capital loss, e.g. on marketable securities, to offset the realized capital gain.
Defer utilization of capital loss to the year of realizing large capital gain.
For sale of a real property with capital gain of more than $250,000, arrange VTB loan with the purchaser to defer partial capital gains over the next few years.
For new investments, register under a join account with family members to create double or multiple annual $250,000 limit of capital gain.
Investing directly by individual rather than by a corporation.
Instead of cash donations, donate marketable securities with highest unrealized capital gains, as the capital gains will be exempted from tax. This is especially tax effective when donating upon death to shelter the tax on large capital gains resulting from the deemed disposition rule.
Work or review with professional accountant on estate planning as early as possible to minimize the increased tax payable on capital gains resulting from deemed disposition of capital properties upon death.
Consideration:
Adding spouse on title of investments may trigger attribution rule as it may be treated as a gift. Under the attribution rule, any future income and capital gain from the investments will be attributed back to the gifting spouse and added to his/her income. The intended goal of sharing income and capital gain between spouses will be defeated.
Transferring property to adult children may expose the property to risk of family wealth division between adult children and their spouses upon their separation.
Corporations:
Impact:
All realized capital gains in the corporation will be subject to 2/3 inclusion rate;
For fiscal year covering June 25, 2024, the corporations are required to track capital gains realized before and after June 25, 2024 due to different inclusion rates to be applied.
CDA inclusion will be reduced, which results in lower tax-free capital dividend payment to the shareholders.
Higher CG inclusion rate will increase the corporation’s passive income, over $50,000 of which will claw back the small business deduction at a rate of 1:5.
Illustration:
The following example shows tax payable on $1 million of capital gain realized by a corporation in 2023, in 2024 (assume $500k realized before the tax change and $500k realized after the tax change) and in 2025.
Assume that business owner is in the highest tax bracket, the taxable dividends are non-eligible and there is no change in tax rates over the three years, the business owner will pay $48k more combined corporate and personal tax in 2024 and $96.6k more tax from 2025.
Corporate owners are going to pay $26k more tax in 2024 and $30k more tax from 2025, compared to the individual taxpayer in the previous example. They are penalized by not being granted the annual $250,000 limit at lower inclusion rate like individuals.
Planning Opportunities assuming the budget is enacted:
Same as for individuals,
sell off investments with large unrealized capital gains before June 25, 2024, and if preferred, buy back.
transfer title of investments with highest unrealized capital gains to a related party prior to June 25, 2024.
in the year of realizing large capital gain, sell off investments with unrealized capital loss to offset the realized capital gain.
for business owners, work with professional accountants on estate planning as early as possible.
Declare higher amount of dividend to individual shareholders for them to invest under personal title to utilize the annual $250k limit at lower inclusion rate.
Sell off non-self-use rental property prior to June 25, 2024 and use the funds to purchase real property and lease to an associated operating company for self-use. If structured properly, the business owner may be eligible for the lifetime capital gain exemption on sale of shares of the property company.
Carry out corporate restructure to meet the criteria of QSBC shares in order for the corporate shareholder to utilize lifetime capital gain exemption and CEI.
Carry out corporate restructure to create multiple lifetime capital gain exemption, CEI and annual $250k limit at lower inclusion rate.
Amalgamate a corporation with capital gains with a corporation with capital losses.
Instead of donation under individual name and cash donations, donate marketable securities with highest unrealized capital gains in the corporation.
Corporate owners considering intergenerational transfer of their businesses may consider closing the deal prior to June 25, 2024.
Shelter investment income from tax by purchasing corporate owned life insurance policy as part of the corporation’s tax strategy, and to reduce death tax significantly.
Illustration:
At least two-year planning in advance prior to sale of corporate shares, with a corporate restructure to convert taxable capital gain to tax-free capital gain by utilizing lifetime capital gain exemption. With the new capital gain rules enacted, entrepreneurs can enjoy additional tax break with the CEI.
The following example illustrates the net cost of $200,000 donation in the corporation before and after the proposed tax change by comparing the situations of no donation, $200,000 cash donations and donation of stocks at market value of $200,000. Assume the corporation owns stocks at market value of $400,000 with cost of $100,000 and has enough other income to use up the donations.
By donating stocks, the cost to the corporate owner is only $45k or $30k before or after the tax change to donation $200,000 from a corporation.
Consideration:
The corporate owners in many business sectors will not be eligible for the CEI, including restaurants, hotels, arts, entertainment, recreation, personal services, finance, insurance, real estate firms and professional corporations.
Before selling off investments prior to June 25, 2024, one should consider the risks and costs associated with taking actions now.
There could be chances that the proposal will not be enacted, or even enacted, the law might be changed in the future to reduce the CG inclusion rate;
By considering time value of money, the cost of immediate tax payment by selling off investments now may exceed increased return of investments at higher inclusion rate if selling in the long run.
The Canadian tax system, especially around private corporations, has become unprecedently more complicated than before, with the accelerated tax changes over the last few years. It is important that you review your situation or consult professional accountant before June 25, 2024 to design a tax effective strategy tailored for your specific situation.