The 2024 Federal Budget included an increase in the capital gains inclusion rate from one-half to two-thirds for corporations and trusts, and from one-half to two-thirds on the portion of capital gains realized in the year that exceed $250,000 for individuals, for capital gains realized on or after June 25, 2024.
In this blog, we dive deeper into these changes and whom they affect.
What is a capital gain?
A capital gain is a profit that is realized by the sale of certain assets, such as stocks, bonds, crypto, or investment properties.
For example, if you buy shares of Apple for $100,000 and later sell it for $200,000, you will have a $100,000 profit or capital gain.
How were capital gains taxed before June 25, 2024?
A portion of the profit made on the sale of an asset is taxable in Canada. Before June 25, 2024, half of the profit was considered taxable. Said differently, 50% of the capital gains had to be included in a taxpayer’s income. This 50% is often referred to as the “inclusion amount”.
To illustrate, if an individual experienced a $100,000 profit by selling Apple stock, they would have to include half of that profit, or $50,000, in their income in the year that the sale occurred. That $50,000 would be taxed at that individual’s marginal tax rate. If their income were greater than $246,752 in 2024, they would be at the highest marginal tax rate of 53.53%. They would pay $26,765 in taxes. So, on their $100,000 profit, they would keep $73,235.
How are capital gains now taxed (as of June 25, 2024)?
The capital gains inclusion rate has been increased from one-half to two-thirds. That means that two-thirds of the capital gains or profits must now be included in an individual’s income.
Looking at the same example again, if the individual experienced a $100,000 profit by selling their shares of Apple stock, the individual would now include 66.66% (two-thirds) of the profit in their income for the year. If they were in the highest marginal tax rate, they would pay 53.53% on this higher amount of $66,666, which translates into $35,687 in taxes owed. Of their original $100,000 profit, they would be able to keep $64,313 (instead of $73,235 in the above example). In other words, these changes would cost the individual approximately $9,000 in additional taxes on the $100,000 profit.
However, the government intended to increase the tax paid by those who experienced higher capital gains and not to tax those who were experiencing smaller capital gains. They set an annual threshold of $250,000. Therefore, if an individual were to experience a capital gain of $250,000 or less, they would still be treated under the old inclusion rate (50%). Once they exceed $250,000 in capital gains, the excess would fall under the new inclusion rate (66.67%).
While this does allow some flexibility for individuals to sell certain assets and not be taxed at a higher level, we will share some examples of situations where higher taxes will be experienced.
Is this different within a Canadian Controlled Private Corporation (CCPC)?
Capital gains in a corporation are taxed similarly to individuals. Once again, looking at the above example, but this time assuming the stocks were sold in a CCPC, the corporation would experience a $100,000 profit by selling the shares of Apple stock, which would now include 66.67% (two-thirds) of the profit in the corporation’s income for the year. The corporation pays a tax rate of 50.2% tax on passive income, including investment income. Applying 50.2% on the increased inclusion of $66,667 translates into $33,466 in taxes owed. The corporation would have a net profit of $66,533. Before the changes, the corporation would have paid $25,100 in taxes. In other words, these changes would cost the corporation approximately $8,400 in additional taxes on the $100,000 profit.
Corporations were not granted a $250,000 threshold at 50%. They are taxed on all capital gains at the two-thirds inclusion rate. This will disproportionately disfavour business owners and professionals, such as physicians and dentists, who invest their retirement assets in their corporations.
Were capital gains always taxed with a 50% inclusion rate?
Capital gains were not always taxed with a 50% inclusion rate.
- Pre-1972 – Before capital gains taxes were first introduced in 1972, capital gains were tax-free.
- 1972 to 1988 – The inclusion rate was at 50%.
- 1988 to 1990 – The inclusion rate was increased to 66.67%
- 1990 to 2000 – The inclusion rate was further increased to 75%.
- February 2000 – The inclusion rate was dropped back to 50% where it remained until June 25, 2024.
Not all assets that are sold are taxed as capital gains
There are certain exemptions in Canada where capital gains taxes do not apply.
- You are selling your principal residence. When you sell a property deemed a principal residence for every year you own it (e.g., a house, cottage, or condo), you would not need to pay capital gains taxes on any gains on this property.
- Profits made in various tax-sheltered vehicles, such as RRSPs, RRIFs, TFSAs, or RESPs, are not taxable when sold and therefore do not attract capital gains taxes in the year they are sold. For example, if the Apple shares discussed above were held in your RRSP and were sold, no capital gains would have to be paid in the year the sale was made. However, funds withdrawn from certain vehicles, such as RRSPs and RRIFs, will be fully taxable when the funds are withdrawn from these tax-sheltered plans. TFSAs on the other hand, attract no taxes at all even when the funds are withdrawn.
- Gains in a life insurance policy are generally tax-sheltered. Insurance policies are not only advantageous in ensuring that individuals protect their financial dependents should they pass away, but certain policies can also be used as vehicles to invest in a tax-sheltered way. Withdrawals from a life insurance policy may be considered regular income and are not considered capital gains.
- Selling qualified small business corporation shares (QSBCS) or qualified farm and fishing property (QFFP). These refer to the sale of shares of a small business or farm and fishing property in Canada (these must satisfy CRA rules and definitions surrounding QSBCS and QFFP). Before June 25, 2024, the first $1,016,836 of capital gains incurred by the disposition of these shares or property did not attract taxes. These lifetime capital gains exemptions (LCGE) are in place to encourage entrepreneurs and investors to build small businesses in Canada. They are also in place to help incent farming in Canada. As of June 25, 2024, this exemption has increased to $1.25M. So, if the gains are less than the new lifetime capital gains exemption, selling QSBCS or QFFPs will result in less tax. However, once the gains surpass the LCGE, as well as the personal threshold amount, business owners and farmers will be paying higher taxes (see example here – Successful Farms and Businesses that Sell).
Who will be most affected by these changes?
Individuals who own investment properties with large gains
Many Canadians own a primary (principal) residence and a secondary property. Some purchased cottages many years ago and have watched its value increase significantly over time. Imagine an Ontario family that purchased a house in Etobicoke in the 1980s. They also purchased a cottage in Muskoka at the same time. They worked hard to pay off their debt during their working years and always assumed they would sell one of their properties to fund their retirement. They would only be able to claim one of the two properties as a principal residence, which means the other would attract capital gains taxes. Given the new changes, if the gains are significant (for example $1M), this could mean higher taxes (an additional $23k in taxes owed).
Taxes at death
At the time of death in Canada, residents are deemed to have disposed of all their property at fair market value immediately preceding their death. Whether or not they sold their property, they are assumed to have done so for tax purposes. This may cause a capital gain at death (e.g., if the deceased held secondary properties or shares of companies in non-tax-sheltered accounts). These capital gains will often be taxed at a higher level in the year of death. If the individual still has a spouse, the assets may be able to roll to the surviving spouse without incurring taxes, but on the spouse’s death, no such opportunity exists. As such, for many, the capital gains taxes at death will be higher under this new regime than it would have been under the previous rules.
Corporate investments
Many professionals, such as physicians and dentists, cannot rely on government-funded pensions. They must build up their retirement assets by using corporations and registered accounts. They leave funds in their corporations to invest. By not taking funds out of the corporation until they retire, they defer paying additional personal taxes until that time. When the funds are invested in the corporation, they are taxed. As mentioned above, the lack of a $250,000 threshold for corporations means that every dollar of capital gains will be taxed at a higher level. This means that all individuals who invest in corporations will pay an additional 8.36% in their corporations on capital gains.
Successful farms and businesses that sell
Imagine a farm family that sells their QFFP to another farmer. This farm has been in the farmer’s family for generations and has large capital gains or profit of $10M when sold. The first $1.25M of this profit would not be taxable as capital gains. If the farm were held jointly with a spouse, this amount could be doubled, where up to $2.5M would not be taxable. They would also each be eligible for the $250,000 personal threshold where the capital gains inclusion rate would be 50%. The remaining $7M would have an inclusion rate of two-thirds. They would include $4.98M (0% x $2.5M + 50% x 500k + 66.67% x $7M) in their income as taxable capital gains and would pay at the highest marginal tax rate of 53.53%, amounting to $2.66M in taxes. Had they sold prior to June 2024, they would have paid $2.13M in taxes (0% x $2,033,672 + 50% x $7,966,328). This farm family would pay over $500k in additional taxes.
Are there any strategies to reduce the impact of this increased tax?
As always, having a competent and integrated professional team that is forward-looking and looking out for your best interests is important. These changes will affect many but may not change the current wealth strategies being employed. For example, investing in corporations and deferring personal taxes still makes sense despite the increased tax on capital gains. The deferral benefits outweigh the additional tax cost.
Using TFSAs where appropriate, with extra cash flow to invest, makes more sense given these changes. The current contribution room in 2024 for those who have never contributed may be as high as $95k.
Permanent insurance policies can act as tax-deferral mechanisms by helping to defer taxes on capital gains within the policies. These gains can potentially be fully eliminated at death. Structuring these policies correctly can assist in reducing the overall tax cost of disposing of corporate shares at death. They can also be used to plan for expected capital gains taxes. For example, if a family would like to keep a property or a business in the family and want to fund the capital gain taxes at death, life insurance can play an increasingly important role in ensuring these assets remain in the family.
For further inquiries regarding these changes, how they may affect your situation, or what you can do to plan for them, please do not hesitate to contact your Tall Oak team. We’re here to assist you every step of the way.
*tax rates in Ontario
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