2/3 Isn’t Bad…It’s Criminal!

On April 16, 2024 the Federal Government released Budget 2024.  Of particular interest is the increase in the capital gains inclusion rate from 1/2 to 2/3, effective for dispositions realized after June 24, 2024.

 

As a quick refresher, capital gains are taxed differently from other types of income.  When a capital gain is realized, only a portion of the gain (referred to as the “inclusion rate”) is included in income.  Since the year 2000, the inclusion rate has been at 50% (since 1972,  the rate has fluctuated between 50% and 75%).

 

For corporations and trusts that don’t allocate income to its beneficiaries, the increase to the inclusion rate applies to the entire amount of any capital gains realized after June 24, 2024.  For individuals (assuming the gain doesn’t qualify for the lifetime capital gains exemption or the new entrepreneurial exemption), there is an arbitrary annual exemption for the first $250,000 of gains realized in a year that will be taxed at the existing 50% inclusion rate.

 

For example, if an individual taxpayer at the highest marginal rate of 53.53% realizes a $500,000 capital gain on or before June 24, 2024, $250,000 is not taxable and the other $250,000 is taxed at 53.53%.  This results in a net tax rate of 26.77%.

 

Assuming the same taxpayer realizes $500,000 of capital gains  after June 24, 2024,  $207,500 is not taxable and the remaining $292,500 is taxed at 53.53%.  This results in a net tax rate of 31.31%, representing a 17% increase in taxes payable.

 

Since corporations and trusts don’t benefit from the $250,000 exemption, every dollar of capital gains realized will be subject to the increased inclusion rate, effectively resulting in a 33% increase in taxes payable.  The 33% increase in taxes payable also applies to individuals on gains in excess of $250,000 in a particular year.

 

Although we have not yet seen the draft legislation that will enact these proposed changes, some preliminary planning opportunities come to mind, including:

 

  1. Intentionally realizing (by way of sale, gift, liquidation, reorganization of share structure, etc.) capital gains prior to June 25, 2024 such that the entire gain is subject to the existing 50% inclusion rate.  This strategy can be done both corporately and personally (although AMT issues and potentially GAAR issues need to be considered carefully).
  2. Implementing an estate freeze combined with a family trust structure and life insurance planning since the tax cost related to the deemed disposition on death will also be subject to the increased inclusion rate (unless there is a specific exemption introduced in the legislation);
  3. Income splitting using prescribed rate loans (however, the current prescribed rate of 6% generally makes this strategy unattractive); 
  4. Departing Canada is also a possible strategy although this is more of a change of lifestyle than strictly tax planning.  This option is typically the most complex with several issues (including AMT) that need to be considered. 
  5. Defer realizing capital gains until some time in the future when the inclusion rate may be back to 50%.

At this point in time, my preferred planning strategy is a combination of Option #1 (in certain fact patterns) given the short time-frame leading up to June 25, 2024, its relatively quick to implement, and Option #2 as it provides several estate planning benefits,  and is not considered aggressive nor subject to GAAR, and is also relatively quick to implement (although timing is less of an issue generally).