Provided by: MNP
The 2024 federal budget, entitled Fairness for Every Generation, was delivered by the Honourable Chrystia Freeland, Deputy Prime Minister and Minister of Finance, on April 16, 2024.
This article will provide background on the increase in the capital gains inclusion rate from 50 percent to 66.67 percent and how it will impact professionals.
The Canadian government announced that updated draft legislation will be forthcoming. The full implications of this announced rule change will not be known until legislation is finalized and passed into law.
Capital gains inclusion rate
The capital gains inclusion rate has increased from 50 percent to 66.67 percent for corporations and most types of trusts for capital gains realized on or after June 25, 2024.
Additionally, for individuals and select types of trusts, the inclusion rate also rose from 50 percent to 66.67 percent on the portion of capital gains exceeding a $250,000 threshold realized in a year.
Capital gains realized by corporations
Professionals that realize a capital gain in their professional corporation will pay about seven percent to 10 percent more income tax on capital gains realized on or after June 25, 2024, depending on their province of residence.
Consider the following example for a professional located in Ontario: Dr. A wholly owns shares of A Professional Corporation (APC). APC sells a marketable security and incurs a capital gain of $100,000. Dr. A will pay an extra combined personal and corporate income tax of $9,655 for selling the marketable security on or after June 25, 2024, compared to if the marketable security was sold prior to this date. This is because APC will pay more corporate income tax with the higher capital gains inclusion rate, leaving less cash available to pay as dividends to Dr. A.
APC cannot pay as high of a tax-free capital dividend to Dr. A with the increased capital gains inclusion rate. In addition, Dr. A will pay more personal income tax because a higher taxable dividend will need to be paid from APC to extract all the marketable security sale proceeds after corporate income tax has been paid.
This is illustrated as follows:
| Line Item | Pre-June 25, 2024 | June 25, 2024 and onwards |
|---|---|---|
| Capital Gain Realized by Corporation | $100,000 | $100,000 |
| Inclusion rate | 50.00% | 66.67% |
| Taxable Capital Gain | 50,000 | 66,667 |
| Corporate Income Tax | (9,750) | (13,000) |
| After-tax funds available | 90,250 | 87,000 |
| Tax-free Capital Dividend | 50,000 | 33,333 |
| Taxable dividend | 40,250 | 53,667 |
| Personal Income Tax | (19,215) | (25,620) |
| Personal after-tax funds received | 71,035 | 61,380 |
| Effective Income Tax Rate | 28.97% | 38.62% |
| Net Tax Cost | 9,655 | |
Capital gains realized by individuals: Under $250,000
The first $250,000 of capital gains realized by an individual in a particular year will remain taxable at a 50 percent inclusion rate. Therefore, professionals will pay the same income tax when realizing a capital gain on or after June 25, 2024, than they would have paid if they realized a capital gain before June 25, 2024, if the total capital gains realized in a particular year is less than $250,000.
This is illustrated for an Ontario professional as follows:
| Line Item | Pre-June 25, 2024 | June 25, 2024 and onwards |
|---|---|---|
| Capital Gain Realized by Individual | $100,000 | $100,000 |
| Inclusion rate on first $250,000 | 50.00% | 66.67% |
| Inclusion rate on >$250,000 | 50,000 | 66,667 |
| Taxable Capital Gain | 50,000 | 50,000 |
| Personal Income Tax | (26,765) | (26,765) |
| Personal after-tax funds received | 73,235 | 73,235 |
| Effective Income Tax Rate | 26.77% | 26.77% |
| Net Tax Cost | 0 | |
Capital gains realized by individuals: More than $250,000
Professionals that realize total capital gains of greater than $250,000 in a particular year will pay additional personal income tax on or after June 25, 2024, compared to if they realized capital gains prior to this date. The amount of income tax paid will depend on the professional’s province of residency.
It will also depend on the total amount of capital gains incurred in a particular year because the first $250,000 of capital gains are subject to the 50 percent inclusion rate whereas the capital gains beyond $250,000 are subject to the 66.67 percent inclusion rate.
Consider the following example for an Ontario professional: Z is a lawyer that personally owns the property in which they operate their law practice. Z sells the property and incurs a capital gain of $1,000,000. Z will pay additional personal income tax of $66,912 for selling the property on or after June 25, 2024, compared to if the property was sold prior to this date. This is because the first $250,000 of capital gain will be taxed with an inclusion rate of 50 percent, whereas the remaining capital gain will be taxed with an inclusion rate of 66.67 percent.
This is illustrated for an Ontario professional as follows:
| Line Item | Pre-June 25, 2024 | June 25, 2024 and onwards |
|---|---|---|
| Capital Gain Realized by Individual | $1,000,000 | $1,000,000 |
| Inclusion rate on first $250,000 | 50.00% | 50.00% |
| Inclusion rate on >$250,000 | 50,000 | 66,667 |
| Taxable Capital Gain | 500,000 | 625,000 |
| Personal Income Tax | (267,650) | (334,562) |
| Personal after-tax funds received | 732,350 | 665,438 |
| Effective Income Tax Rate | 26.77% | 33.46% |
| Net Tax Cost | 66,192 | |
The nuances of draft legislation
The $250,000 threshold for the 50 percent capital gains inclusion rate will apply to capital gains realized by an individual (not a corporation) in a year, either directly or indirectly via a partnership or trust, net of any current year capital losses.
It does not apply to income earned by a trust unless the trust is a graduated rate estate trust or a qualified disability trust.
The $250,000 threshold will factor in tax deductions taken for capital losses from other years applied to reduce capital gains in the current year, as well as exemptions like the lifetime capital gains exemption, the employee ownership trust exemption, and the Canadian Entrepreneurs’ Incentive.
Recent changes to the alternative minimum tax will also need to be considered when determining the amount of income tax payable by an individual that incurs a capital gain.
There are transition rules effective when capital gains are realized in 2024 whereas capital gains will need to be identified as being incurred before June 25, 2024 (Period 1) or being incurred on or after June 25, 2024 (Period 2) so that the applicable inclusion rate can be applied.
Lastly, taxpayers who incurred a capital gain in a prior year and were able to pay the income tax in future years (referred to as claiming a reserve), including 2024, because they were not paid in full at the time of sale need to review whether the 66.67 percent inclusion rate will apply going forward.
This report is provided by MNP. It is for informational and educational purposes only as of the date of writing. This information should not be considered investment, tax or legal professional advice. For specific advice about your situation, please consult a tax, accounting, legal or financial professional. The information contained in this report has been drawn from sources believed to be reliable but is not guaranteed to be accurate or complete. CDSPI, CDSPI Advisory Services Inc., MNP and our affiliates are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.