The Government of Canada has recently unveiled its Federal budget for 2024, introducing several pivotal changes likely to impact Canadians and businesses across the country. These changes are primarily aimed at high-income Canadians who regularly realize substantial capital gains in a non-registered portfolio each year, but they may also affect other people in a number of ways. Below, we explore the most talked-about taxation changes in the budget and delve into how these might affect you.
Increase in Capital Gains Inclusion Rate
One of the significant changes announced is the increase in the capital gains inclusion rate, which will affect capital gains realized on or after June 25, 2024. Previously, the inclusion rate was 50%, but the new budget proposes increasing this rate to 66.67% for individuals, corporations, and trusts.
First of all, what is a capital gain? It’s the difference between an asset’s cost and its total sale price. Some examples of an asset could be a cottage, an investment property or shares in a corporation, including stock purchased as an investor in a mutual fund. Using the cottage as an example, let’s say you purchased it for $700,000 and later sold it for $1,000,000. You would have a capital gain of $300,000. It is important to note that the sale of your principal residence is not subject to capital gains tax due to the principal residence exemption.
Individuals
For individuals, the inclusion rate increase applies to capital gains realized in the year that exceed a threshold of $250,000. Let’s look at the impact of this using the above example, assuming a 48% tax rate.
Before June 25, 2024:
$300,000 total capital gain
Inclusion rate of 50% on the total gain = $150,000 portion of the gain that is taxable
Total tax liability = $72,000
June 25, 2024 Going Forward:
$300,000 total capital gain
Inclusion rate of 50% on the first $250,000 = $125,000 portion of the gain that is taxable
Inclusion rate of 66.67% on the $50,000 above the threshold = $33,335 portion of the gain that is taxable
Total tax liability = $76,000
The delayed implementation date of June 25, 2024, provides an opportunity for taxpayers to voluntarily ‘crystallize’ meaningful capital gains accrued prior to June 25, 2024, so that such historical capital gain will not be subject to the increased inclusion rate. There are pros and cons to crystallization transactions, and it is important to properly review such planning prior to June 25th.
Corporations
Corporations will be subject to the increased capital gains inclusion rate on all capital gains. There is no threshold as such for individuals and the inclusion rate of 66.67% applies to every dollar of capital gain realized. Capital gains in a corporation can be realized when you make a profit from selling things such as buildings, equipment, and shares. Much like the cottage example we used for an individual, the capital gain is the difference between the costs to purchase including associated costs such as commissions and legal fees, and the sale price.
Let's provide a detailed breakdown of the calculation for a corporation's sale of shares, including the purchase details and individual costs associated with establishing the Adjusted Cost Base (ACB). This will give a clearer picture of how the capital gain and consequent tax liability are determined under both the old and new inclusion rates.
Purchase and Sale Details:
Shares Purchased: 10,000 shares
Purchase Price per Share: $20
Total Purchase Price: $200,000
Selling Price per Share: $80
Total Sale Price: $800,000
Additional Costs (included in ACB):
Legal Fees: $5,000
Brokerage Fees: $3,000
Other Acquisition Costs: $2,000
Total Costs (ACB): $210,000
Calculation of Gain:
Sale Proceeds: $800,000
Adjusted Cost Base (ACB): $210,000
Capital Gain: Sale Proceeds - ACB = $800,000 - $210,000 = $590,000
Before June 25, 2024:
Taxable Gain: 50% of $590,000 = $295,000
Corporate Tax Rate Assumption: 15%
Tax Payable: 15% of $295,000 = $44,250
June 25, 2024 Going Forward
Taxable Gain: 66.67% of $590,000 = $393,353
Tax Payable: 15% of $393,353 = $59,003
This detailed scenario emphasizes the importance of understanding all components of the capital gains calculation, including the accurate computation of the ACB, which incorporates all costs associated with the purchase of the asset. Understanding these details helps in strategic financial planning and managing tax liabilities more effectively.
Enhanced Lifetime Capital Gains Exemption
Some business owners who sell their qualifying small business corporation shares may be able to take advantage of the soon-to-be-enhanced lifetime capital gains exemption (LCGE), which is rising from $1,016,836 to $1.25 million as of June 25, 2024.
Determining whether you are qualified for the LCGE can be complicated and requires analysis from a professional, the basic requirements are:
Your company must be a small business corporation (SBC) at the time of the sale.
It must be a share sale of your business (sole proprietorships and partnerships do not qualify).
More than 50% of the business’s assets must have been used in an active business in Canada for 24 months prior to the sale.
The shares must not have been owned by anyone other than you or someone related to you in the 24-month period before the sale.
To analyze the impact of the changes in the Lifetime Capital Gains Exemption (LCGE) and the capital gains inclusion rate, let's look at an example of a corporation selling shares and realizing a capital gain of $1,500,000. We will compare the tax implications before and after the changes announced in the 2024 federal budget of Canada.
Sale Proceeds: $2,000,000
Adjusted Cost Base (ACB): $500,000
Capital Gain: $1,500,000
We will compare the scenario under the old LCGE limit of $1 million with the new LCGE limit of $1.25 million, and consider the changes in the capital gains inclusion rate from 50% to 66.67%.
Before June 25, 2024:
LCGE: $1 million
Capital Gains Inclusion Rate: 50%
Corporate Tax Rate: 15% (hypothetical for illustration)
Calculation:
Capital Gain: $1,500,000
LCGE Applied: $1,000,000
Remaining Gain Subject to Tax: $1,500,000 - $1,000,000 = $500,000
Taxable Gain (50% Inclusion): 50% of $500,000 = $250,000
Tax Payable: 15% of $250,000 = $37,500
June 25, 2024 Going Forward:
LCGE: $1.25 million
Capital Gains Inclusion Rate: 66.67%
Calculation:
Capital Gain: $1,500,000
LCGE Applied: $1,250,000
Remaining Gain Subject to Tax: $1,500,000 - $1,250,000 = $250,000
Taxable Gain: 66.67% of $250,000 = $166,675
Tax Payable: 15% of $166,675 = $25,001.25
In both scenarios, the LCGE is fully utilized, but with the increase in LCGE, the tax owing is decreased by $12,498.80, despite the increase in the capital gains inclusion rate.
Conclusion
The 2024 federal budget introduces substantial changes that will impact different segments of the Canadian population in various ways. For investors and those in the business sector, the increase in the capital gains inclusion rate will require careful tax planning and consideration. At the same time, the government's initiatives in housing, AI, and clean energy present new opportunities for growth and investment. For more tailored advice on how these changes may impact your personal or business financial planning, please do not hesitate to contact us.
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