On April 16, 2024, the Canadian government announced significant changes to the capital gains inclusion rate in Budget 2024, impacting how individuals and corporations report and pay taxes on capital gains. Additional details were released on June 10, 2024, detailing the rules. Starting June 25, 2024, the inclusion rate for capital gains will increase from one-half to two-thirds for corporations and trusts, and for individuals with gains exceeding $250,000 CAD in a taxation year.
Understanding the New Inclusion Rate
Basic Inclusion Rate and Threshold for Individuals and Some Trusts
The basic inclusion rate for all capital gains and losses will increase from one-half to two-thirds as of June 25, 2024. However, for individuals, Graduated Rate Estates, and Qualified Disability Trusts, the first $250,000 of capital gains realized in a year will still be included at the previous one-half rate. Any capital gains exceeding this threshold will be subject to the new two-thirds rate. Note that the $250,000 threshold will not be indexed annually, meaning it will not increase to adjust for inflation.
Impact on Corporations and Trusts
For corporations and all other types of trusts, the entire capital gain will be included at the two-thirds rate. Note that a trust that does not pay the tax within the trust and instead distributes up to $250,000 of capital gains to an individual beneficiary should be entitled to the $250,000 one-half rate per individual beneficiary. These changes are substantial for any person with a Canadian corporation or a Canadian trust and will require careful planning each year, as well as potential restructuring to mitigate the increased tax liability.
Practical Examples
Example 1: Individual with Significant Capital Gains
Consider an individual who realizes a $450,000 capital gain and a $50,000 capital loss in 2025. The new rules would apply as follows:
- Net capital gain for the year: $400,000.
- The first $250,000 of the gain is included at the one-half rate (taxable capital gain of $125,000).
- The remaining $150,000 is included at the two-thirds rate (taxable capital gain of $100,000).
- Total taxable capital gain: $225,000.
Assuming the taxpayer is already at the top marginal tax bracket in Ontario, the tax associated with this $225,000 taxable capital gain is $120,443, which is $13,383 higher than the $107,060 payable if the entire net capital gain of $400,000 was taxed at the one-half inclusion rate.
Example 2: Transition Year Considerations
In a transition year spanning June 25, 2024, taxpayers must separate gains and losses realized before and after this date:
- Gains before June 25, 2024: One-half inclusion rate.
- Gains after June 25, 2024: Two-thirds inclusion rate, with the first $250,000 for individuals still at the one-half inclusion rate.
For instance, if Robert realizes $600,000 in gains before and $475,000 after June 25, 2024, his taxable capital gains would be calculated by applying the respective inclusion rates to each period’s gains. $600,000 * ½ = $300,000; + $250,000 * ½ = $125,000; + $225,000 * 2/3 = $150,000; $575,000 total taxable gain.
Net Capital Loss Adjustments
Net capital losses from previous years can be carried back three years and forward indefinitely to offset current-year capital gains. These losses must be adjusted to reflect the inclusion rate of the year they are being applied. For example, a capital loss realized when the rate was one-half can offset gains realized when the rate is two-thirds by adjusting the loss using specific factors provided by the CRA.
Example 3: Net Capital Loss Adjustments
Consider the same individual who realizes a $450,000 capital gain and a $50,000 capital loss in 2025, but also has a net capital loss of $150,000 from 2017 (capital loss of $300,000). The new rules would apply as follows:
- Net capital gain for the year: $400,000.
- The first $250,000 of the gain is included at the one-half rate (taxable capital gain of $125,000).
- The remaining $150,000 is included at the two-thirds rate (taxable capital gain of $100,000).
- Total taxable capital gain before the loss carryforward from 2017: $225,000.
- The 2017 loss carryforward is deducted as $100,000 in respect of the portion of the net capital loss that offsets the portion of the taxable capital gain included in income at two-thirds ($75,000 × adjustment factor 4/3), and deducted as $75,000 in respect of the portion of the net capital loss that offsets the portion of the taxable capital gain effectively included in income at one-half ($75,000 x adjustment factor 1).
- Total taxable capital gain after the loss carryforward from 2017: $50,000.
Employee Stock Option Deductions
The inclusion rate changes also affect the taxation of employee stock options. For options exercised on or after June 25, 2024, a basic one-third deduction will apply to the taxable benefit, reflecting the new inclusion rate. This deduction can be increased to one-half on up to $250,000 of combined employee stock option benefits and capital gains.
Example 4: Stock Option Benefits
If Lindsay realizes a $125,000 capital gain and $200,000 in employee stock option benefits in 2027, she can choose to apply the one-half inclusion rate to either the stock option benefits or the capital gains, optimizing her tax outcome based on her total income.
As a result of this election, $50,000 of the capital gain would effectively be included at a one-half inclusion rate and the remaining $75,000 would be included at a two-thirds inclusion rate, for a total taxable capital gain of $75,000 ($50,000 × ½ + $75,000 × ⅔).
Alternatively, Lindsay can elect to have the one-half inclusion rate apply to the full amount of the capital gain, resulting in a taxable capital gain of $62,500 ($125,000 x ½). She can receive a one-half deduction on $125,000 of her stock option benefit and one-third on the remaining $75,000, for a total deduction from taxable income of $87,500 ($125,000 x ½ + $75,000 x ⅓).
Lifetime Capital Gains Exemption (LCGE)
The LCGE, which provides a lifetime exemption on capital gains from qualified small business corporation shares, and qualified farm and fishing property, will also adjust. The limit increases to $1.25 million for eligible gains realized on or after June 25, 2024, with indexation resuming in 2026. The LCGE deduction will be applied consistently regardless of the inclusion rate.
Allowable Business Investment Losses
The deductible proportion of allowable business investment losses (ABIL) will increase from one-half to two-thirds for losses realized on or after June 25, 2024. These losses can offset other income and provide significant tax relief for qualifying business investments.
Example 5: Business Investment Losses
Gervais, realizing a $12,000 capital loss on small business shares on or after June 24, 2024, can use $8,000 (two-thirds) of this loss to offset non-capital income, enhancing his tax planning strategy.
Capital Gains Reserves
It was confirmed that for previous capital gains reserved realized on or after June 25, 2024, the new two-thirds inclusion rate will apply on gains over the $250,000 annual threshold which will continue to be subject to the one-half inclusion rate.
Non-Resident Dispositions of Taxable Canadian Property
If a non-resident of Canada sells Canadian real estate, withholding by the buyer will increase from 25% to 35% of the gross proceeds received on the sale. A Form T2062 – Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property – can be filed to report the principal residence exemption for qualifying years and reduce the withholding to 35% of the net gain (proceeds less cost basis). This new 35% withholding rate will apply after December 31, 2024.
Planning Ahead
These changes necessitate proactive tax planning. Taxpayers should:
- Review Asset Portfolios: Assess which assets may generate significant capital gains and plan their disposition accordingly.
- Utilize Thresholds Effectively: For individuals and those subject to a capital gain reserve, manage the timing of capital gains to stay within the $250,000 threshold where possible.
For trusts, pay out capital gains to individual beneficiaries where appropriate.
For corporations, look to realize gains before June 25, 2024, if you know you will need the cash for other purposes within the next few years.
If departing Canadian tax residency or near the end of life, look to realize gains before June 25, 2024, leaving only $250,000 of unrealized gains to be realized on or after June 25, 2024.
- Optimize Employee Stock Options: Consider the timing of exercising stock options to maximize deductions under the new rules.
- Consult with Tax/Financial Advisors: Engage with tax/financial professionals to navigate the complexities and optimize tax strategies in light of the new inclusion rates.
By understanding these changes and planning accordingly, individuals, trusts, and corporations can better manage their tax liabilities and maximize their financial outcomes. If you would like to review your unique situation, please reach out to Cardinal Point.