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Finance Provides More Details About the Increase in Capital Gains Inclusion Rate

The Department of Finance (“Finance”) previously announced in its 2024 federal budget changes to capital gains, as follows:

  • The capital gains inclusion rate will be increased from 1/2 to 2/3 for capital gains realized on or after June 25, 2024.
  • For an individual at the top marginal tax bracket in Ontario, the first $250,000 of capital gains will be taxed at a combined federal and provincial rate at 26.8% (unchanged). The capital gains beyond the $250,000 threshold will be taxed at 35.7%.
  • The Lifetime Capital gains exemption will be increased to $1,250,000.
  • For Canadian-Controlled Private Corporations (“CCPC”), the effective tax rate on capital gains is expected to increase from 25% to 33.4%.

In the Notice of Ways and Means Motion (“NWMM”) released on June 10, 2024, the government confirmed its intention to proceed with the proposed changes and released more details and clarification on the changes. We have summarized our observations as detailed below.

Capital gains threshold for individuals and specific trusts

Under the proposed rule, the 1/2 inclusion rate will continue to be available for individuals, Graduated Rates Estates, and Qualified Disability Trusts with respect to capital gains realized in the year up to $250,000. The inclusion rate will be increased to 2/3 for the portion of capital gains that exceed the $250,000 threshold.

Where multiple individuals jointly own one property and realize a capital gains on a disposition of that property, each individual would have access to their own $250,000 threshold for the purpose of determining the inclusion rate.

Capital gains reserve

For the purpose of determining the inclusion rate, the amount of prior year’s capital gains reserve would be deemed to be realized and brought to the taxpayer’s income on the first day of the tax year. As a result, for taxation years that begin before June 25, 2024, the amounts of capital gains reserve that are brought into the taxpayer’s income will be subject to the 1/2 inclusion rate.

Net capital losses

Under the current rules, unused capital losses from prior years are deductible against current-year taxable capital gains by adjusting their value to reflect the inclusion rate of the capital gains being offset. Finance confirms that the adjustment would continue to apply to the application of unused capital losses on or after June 25, 2024 to align with the 2/3 inclusion rate.

For tax years that begin before June 25, 2024 and end on or after June 24, 2024, two different basic inclusion rates would apply to capital gains realized in the pre-June 25 and post-June 24 period. Finance clarifies that gains and losses from the same period would first be netted against each other. The annual $250,000 threshold for individuals would apply to net capital gains realized in the post-June 24 period less any net capital loss realized in the pre-June 25 period.

Allowable business investment losses

Finance confirms that, the deductible proportion of an allowable business investment loss (“ABIL”) realized after June 25, 2024 would be increased to 2/3 to align with the increased capital gains rate.

Unlike net capital losses, ABILs are not adjusted to account for the applicable inclusion rate in the year the loss is carried over. That being said, ABILs realized after June 25, 2024 would be determined based on the 2/3 inclusion rate, even if these losses are carried back to any of the three previous years.

Designations of taxable capital gains by trusts

Finance clarifies that, for the purpose of determining the capital gains inclusion rate, capital gains designated by trusts are deemed to be realized by the beneficiary in the period that the trust disposed of the relevant capital property.

For tax years that begin before June 25, 2024 and end on or after June 24, 2024, the trusts would be required to disclose to their beneficiary in a prescribed form with respect to the capital gains realized in the pre-June 25 and post-June 25 period. If no disclosure is made, the capital gains would be deemed to have been realized after June 24, 2024 and subject to the increased inclusion rate.

Allocations of taxable capital gains by partnership

Similar transition rules also apply to partnerships. Capital gains or losses allocated by partnerships are deemed to be realized by their members in the period that the partnership disposed of the relevant capital property. Also, partnership would be required to disclose in a prescribed form with respect to the capital gains, capital losses, and ABILs.

Non-resident disposition of taxable Canadian Property (TCP)

Withholding rate with respect to dispositions of TCP occurred on or after January 1, 2025 by a non-resident of Canada will be increased from 25% to 35%.

GG Observations & Planning Tips

We expect that the change in inclusion rate will have significant tax and cash-flow implications on current and future transactions such as estate planning, intergenerational business transfers, and M&A activities.

We would like to highlight various planning tips to minimize the impacts of the proposed changes in capital gains inclusion rate:

  • Accelerating closing date to utilize the 1/2 inclusion rate. This could also be accomplished by implementing pre-closing reorganizations (i.e., sell the property to a related party and crystalize the accrued gains on the property prior to June 25, 2024), if there is no immediate sale
  • Delaying closing date on the disposition of qualified small business corporation (QSBC) shares with expected gains below $1.5M to take advantage of the increased LCGE of $1.25M and the $250,000 threshold.
  • Carefully structure transactions that contain earnout provisions. Tax treatments could vary significantly depending on the types of earnout provisions. Vendors may want to consider a reverse earnout instead of an earnout on a pre-June 25 closing, where the full capital gain is recognized on closing based on the 1/2 inclusion rate and a loss could be recognized in a subsequent period based on the 2/3 inclusion rate.
  • Where ABILs are available and it is intended to carry back these losses to any of the three previous tax years, the individual should wait until June 25, 2024 to realize the ABILs to utilize the increased inclusion rate.
  • Individual who plans to leave Canada permanently should consider accelerating their emigration from Canada to avoid bigger hit on the “departure tax”.

Your GG advisors can help assess and minimize the effect of the proposed changes on your personal and business financial affairs.

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Authors

Steve Ip

Principal

Steve Ip

CPA, CA, CPA (IL)

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