History, ultimately, will be the judge of the recently proposed capital gains tax hike. The Government argues the extra billions of dollars generated will be invested in programs that give people a fairer chance “to build a good, middle-class life”, but critics say this will deter the risk-taking capital that stimulates economic growth and penalize hard-working business owners and individuals.
Which side you stand will likely depend on your view of the Government’s spending program (and debt management amid 20-year high interest rates) and/or your personal situation. But what is clear is finance minister Chrystia Freeland’s fourth budget landed like a lead balloon among business leaders and entrepreneurs.
In a nutshell, the Government is now asking the wealthy to pay more to fund new spending on the likes of housing, Canada Disability Benefit, a national school food program, and a fund for youth mental health. Few doubt these are worthwhile initiatives, but the decision to increase capital gains tax to do so has left many people anxious that their retirement or succession plans will be negatively affected or at worst derailed.
What’s been proposed?
Essentially, if you dispose of capital property other than your principal residence as of June 25, 2024, you will now be taxed on 66.7% of the profit rather than the current inclusion rate of 50%. For corporations or trusts, this higher inclusion rate applies to all gains, but individuals will still be able to take advantage of the 50% rate on the first $250,000 of realized annual gains.
In terms of actual tax rates, for someone in the top marginal bracket of 53.53%, capital gains at the current inclusion rate of 50% (and therefore the first $250,000 after June 25) is taxed at 26.76%. With the inclusion rate hiked up to 66.7%, the top capital gains tax rate goes up to 35.69% for high earners. On $100,000 of capital gains, that’s an increased tax burden of $8,930.
On the positive side, capital losses carried forward can still be deducted against taxable capital gains in the current year by adjusting their value to reflect the new inclusion rate.
As an aside, some historical and geographical context is useful - we are not in unprecedented territory. Canada’s capital gains inclusion rate was 75% through the 1990s until 2000 when it was dropped to 66.7% and then reduced further to 50% that same year. This is the first increase since then.
It’s also worth noting the Government’s argument that these changes keep Canada’s capital-gains tax in line with New York and California – two behemoths of finance and innovation. Canada’s top tax rate on capital gains is now set to rise to 36%, hot on the heels of California (37%) and the Big Apple (38%). Whether these are fair comparisons is open to debate.
Who does it affect?
A central dispute since the proposal was announced is how far reaching this hike will or won’t be. The Budget text itself proclaims that for 99.87% of Canadians, personal income taxes on capital gains will not increase. Critics have decried this as ridiculous as it fails to account for scenarios beyond individuals realizing substantial capital gains in a non-registered portfolio.
Firstly, individual shareholders of the hundreds of thousands of private corporations owned by individuals will feel the tax increase via the dividend distribution required to recover their Refundable Dividend Tax on Hand (RDTOH). Shareholders at public corporations will also likely be hit by the decreased amounts available to pay out as dividends.
Secondly, a significant number of Canadians own a second property, perhaps inherited decades ago from their parents or grandparents. If they sell that property on or after June 25, any gain of more than $250,000 will be taxed at the higher inclusion rate.
Thirdly, business owners of small- to medium-sized enterprise will be subject to the higher rates if they sell their business and go over the $250,000 threshold, which many will be hoping to do. Most will take advantage of the lifetime capital gains exemption (LCGE), which is rising to $1.25 million as of June 25, but gains above this, and subsequently above the $250,000 threshold, will be impacted. There is further nuance here, however. The LCGE stipulates that the next $2 million of capital gains after the $1.25 million will be taxed at a lower 33% inclusion rate but only for certain industries. Those in finance, real estate, consultancy or insurance, for example, won’t have access to this lower rate.
Finally, for many, the biggest disposal of your capital property occurs at death. As well as property, if you leave behind a sizable non-registered investment portfolio, the 66.7% tax rate will apply on any capital gains above $250,000.
What to do
Time may be of the essence to some investors. If you hold investments that you expect will exceed $250,000 in gains after June 25, it could make sense to realize these before that deadline and take advantage of the 50% inclusion rate while it’s still here. The same applies if you hold securities inside a corporation, as you won’t get a break post June 25 on the first $250,000.
Getting “ahead” of the game may not be for everyone. The question is whether the tax savings now are more efficient for you than staying invested and taking a potentially bigger tax hit down the road. For high earners, the new AMT flat rate of 20.5% on taxable income - increased from 15% in 2024 – may also come into play.
Every situation is different, of course, but there will be a laser focus on that $250,000 threshold from a financial planning standpoint. Talk to your Q Wealth Portfolio Manager to understand what impact the proposed changes have on your portfolio and what the best next steps might be.
