Anything to do pre-June 25, 2024 as a result of capital gains tax increases?

APRIL 18, 2024

This week the government announced significant changes to the taxation of capital gains.  The government is giving taxpayers a 10 week window until June 25, 2024 to decide if they want to realize capital gains now at the “old inclusion rate” of 50% – or wait for the 66.67% inclusion rate applied. The purpose of this newsletter is to help clients think about this question:  should I trigger gains prior to June 25 before the new rates apply?

In general, “trigger” means either: (a) realize an immediate taxable gain now and then immediately after repurchase the same position or (b) sell an asset from one company within your structure to another company. For those who realized capital gains in recent years and have taken a provision for proceeds not yet received you should consider realizing any capital gain reserve early, even if they lead to a temporary cash flow hit.

Although the purpose of this note is to focus on triggering gains we should also mention the obvious corollary: for those who are triggering gains they should hold off on triggering losses until the higher rate applies. In many cases we will then carry those losses forward and trigger them in the new higher rate regime.

One more consideration as our clients think through the decision to trigger gains early is the possibility of a Conservative government reversing this decision. With an election in 2025 there is a chance a newly elected government could reverse this increase and make the early triggering unnecessary.

The rules to consider are different for corporations and individuals:

Personal holdings

Individuals can realize up to $250,000 in capital gains per year before they will have to pay tax at the new inclusion rate. Even if you realized $300,000 in capital gains in a given tax year, the new 66.67% capital gains inclusion rate would only be applied to the last $50,000 of capital gains income.

If you hold unrealized capital gains personally and do not anticipate having capital gains of over $250,000 in the near future no action needs to be taken. However, consideration should be taken by individuals in these circumstances:

  • older individuals with a large unrealized capital gains that they will realize on the transfer to the next generation;

  • entrepreneurs planning to sell in their business in the near term or other individuals with large unrealized gains that intend to trigger gains within the next 5 to 8 years to fund lifestyle or capital expenditures; and

  • owners of real estate that they plan to sell in the near term or transfer to the next generation.

Corporate holdings

The new capital gains inclusion rate of 66.67% will apply to all capital gains within a corporation after June 25, 2024.   The result is an increase in immediate corporate tax from 25% to 33% and after paying out all of the gain proceeds to the shareholders the rate will rise from 29% to 39%.

For those holding in corporations, the decision to realize the gain now is a pure time value of money exercise.  The corporation will be stuck with an immediate 25% tax burden in exchange for saving the 33% hit down the road when the shares would normally be sold. For those in retirement or nearing the end of their career, it may well make sense to take advantage of the “old rate”.  To help guide the math it is important to understand that paying the tax today at 25% is approximately equivalent to selling in five years at 33% assuming a 6% rate of return and selling in eight years at a 4% rate of return.   So, if you are a more aggressive investor you might think of realizing gains if you think you will likely realize them within five years and likewise a more conservative investor might choose to realize the gains for anything they expect to sell within 8 years.

In addition to thinking about the likely timing of selling specific assets corporate shareholders should also consider if triggering the gains makes sense based on your personal needs for withdrawing cash from your company.   Even without the recent changes it is important to remember that capital gains are the cheapest way to provide shareholders access to money that is.  RMR will work with their clients on a case by case basis to assist with this exercise.

Individuals with most of their assets inside corporations may wish to adopt strategies that will result in pulling some of their investments to personal hands to take advantage of the lower rate on the first $250,000 of annual gains.  This will not be efficient in many scenarios where the cost of removing assets from a corporation prematurely would trigger large tax bills; however, for corporations with significant balances owing to shareholders it may make sense. The cost of realizing a corporate capital gain and flowing the money out to personal hands in comparison to realizing a capital gain personally for an individual with less than $250,000 of gains has increased from 2% to 12%.

This newsletter focusses on the immediate term and helping frame the decisions that need to be made in the next 10 weeks.

There are other longer-term impacts relating to structure that the new rules will affect.  We will provide additional guidance on this next month.

RMR editorial comment

With Canada’s already high marginal tax rates it is hard to picture being in favour of increases. We live in a competitive world and our rates should be in the ballpark of our neighbours.

Prior to the budget our marginal tax rates were just a nick higher than the average rate in the US.  Capital gains rates vary from state to state but on average 23-25% which was similar to Ontario’s combined rate of 26.5%. (see https://taxfoundation.org/data/all/state/state-capital-gains-tax-rates-2024/ for US rates by state and the top federal rate is 20%).

With the new budget the rate for individuals with large capital gains or corporation will be approximate 33% to 39% which means a significant disadvantage.  While the government indicates that it’s just a little more from those who can afford it we are concerned that with each “small” tweak the government makes Canada’s chances of increasing productivity shrinks a little more.