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Capital Gains Inclusion Rate Changes Impacting Canadian Businesses & Professional Corporations

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In the wake of the 2024 Federal Budget, Canadian business owners and incorporated professionals are bracing for significant shifts in the taxation landscape, particularly concerning capital gains inclusion rates. Moving forward, the proposed changes are going to reshape the strategies used for managing assets, retirement planning, and tax optimization

Understanding the Changes

The most significant change revolves around the capital gains inclusion rate, which is currently set at 50%. This means 50% of all capital gains in a year are added to income for income tax purposes. For individuals, after June 25th, the capital gains rate is set to increase to 66.67% for any gains above a $250,000 threshold. Individuals will be able to incur $250,000 worth of gains at a 50% inclusion rate. Any gains beyond this threshold will face a 66.67% inclusion rate.

Unfortunately for those with trusts and corporations, there is no $250,000 threshold. All capital gains following June 25th will face a 66.67% inclusion rate. This significant change will alter the strategies used for financial and retirement planning, especially for incorporated individuals.

Implications for Businesses: A Comparative Analysis

We can look at an example to illustrate the effects these new changes will have and compare them to the current rules. In this hypothetical scenario, we’ve assumed incorporated professional has triggered a $50,000 capital gain within their corporation to help fund retirement. The example uses Manitoba tax rates, however, the increase in taxes is similar in all other provinces.

Old Rules:

Under the previous regime, with a 50% capital gains inclusion rate for the corporation, the after-tax proceeds amounted to $35,832, with an effective tax rate of 28.66%.

  • $50,000 capital gain
    • $25,000 credits the capital dividend account which can be paid out tax-free
    • $25,000 taxed at 50% (the approximate passive income tax rate)
  • With the gain, there is $12,500 in taxes owing ($4,832 is unrecoverable, and $7,668 is recoverable at a rate of 38.33% for every $1 paid as a non-eligible dividend)
    • To recover the $7,668 a non-eligible dividend of $20,005 must be paid which would result in $9,336 of personal taxes
  • The net result is $14,168 worth of total taxes paid on a $50,000 capital dividend ($4,832+$9,336) with after-tax proceeds amounting to $35,832 which means the effective tax rate on the $50,000 capital gain is 28.66% ($14,168/$50,000=28.66%)

New Rules:

With the proposed rules there will be a 66.67% capital gains inclusion rate for the corporation, with the remainder credited to the capital dividend account (tax-free dividend)

  • $50,000 capital gains
    • $16,667 credits the capital dividend account which can be paid out tax-free
    • $33,333 taxed at 50% (the approximate passive income tax rate)
  • With the gain, $16,666 in taxes is owed ($6,443 is unrecoverable, and $10,223 is recoverable at a rate of 38.33% for every $1 paid as a non-eligible dividend)
    • To recover the $10,223 a non-eligible dividend of $26,671 must be paid which would result in $12,447 in personal taxes owing
  • The net result is $18,890 worth of total taxes paid on a $50,000 capital dividend ($6,443+$12,447) with after-tax proceeds amounting to $30,890 which means the effective tax rate on the $50,000 capital gain is now 37.78% ($18,890/$50,000=37.78%)

That is a difference of $4,722 between the current rules and the proposed changes for June 25th, 2024. This amounts to a 33% increase in taxes paid for the same transaction. If you think 5%-6% inflation is bad, how about an increase of 33%!

Strategic Considerations Moving Forward

Although it’s frustrating that entrepreneurs and health professionals are yet again being targeted, all that can be done is to focus our energy on areas we can control to reduce the drag taxes have on your overall wealth creation.

It’s important to avoid rash decisions like running out and selling assets before June 2024 without knowing the benefit to doing so.

When triggering tax early to avoid paying more later, it’s important to consider the opportunity cost of the upfront taxes that you’d need to pay versus if you continue to hold the asset and defer the tax. You also need to weigh the fact that when triggering capital gains, there will be less credited to your corporation’s capital dividend account (CDA) after June 25th, which allows for tax-free dividends to be paid out to shareholders. For those not needing to sell invested assets to fund income needs in retirement, it can still make sense to hold these assets despite facing higher inclusion rates in the future. For those who regularly draw an income from a corporation, it can make sense to sell and crystalize gains to capture the lower inclusion rate and higher CDA values. However, before making any decision it’s important to have your accountant and other financial professionals prepare a cost-benefit analysis.

Key Financial Instruments to Leverage

To optimize tax planning and wealth creation, consider leveraging the following financial instruments:

  • Paying Salary to Maximize CPP: The Canada Pension Plan benefit is one of the most valuable retirement assets for most Canadians. It’s indexed to inflation and contributions toward CPP will ultimately grow tax-deferred and avoid higher inclusion rates.
  • Registered Investment Accounts: Maximize contributions to RRSPs, TFSAs, RESPs, and FHSAs to capitalize on tax-free growth opportunities and mitigate the impact of capital gains inclusion rates.
  • Permanent Life Insurance*: Explore the benefits of corporately owned permanent life insurance. Permanent life insurance allows policyholders to pay more than the cost of insurance aka the premiums. These extra funds are invested and continue to grow (cash surrender value or CSV). This growth is tax-deferred and avoids the corporate passive income tax rate (50%). They also avoid grinding down a business's access to the small business deduction which allows corporations to pay 9%-12% on active business income and avoids the new capital gains inclusion rate of 66.67%.
  • Individual Pension Plans (IPPs): Explore IPPs as a retirement planning solution. IPPs offer enhanced tax-deferred savings when compared to traditional RRSPs. After age 40, you can contribute significantly more to an IPP than an RRSP and reduce your overall tax burden corporately. It can mean a difference of $700,000 - $1,000,000 more at retirement than traditional RRSPs. Think of IPPs as supercharged RRSPs.

Conclusion

The Federal Budget 2024 ushers in a new era of taxation, with heightened capital gains inclusion rates reshaping the financial landscape for Canadian businesses. If you're concerned about the impact these changes will have and are looking for clarity on how they affect your financial picture, don't hesitate to reach out to me or my team.

This information has been prepared by Brandt Butt who is a Investment Advisor for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

*Insurance products are provided through iA Private Wealth Insurance, which is a trade name of PPI Management Inc. Only products and services offered through iA Private Wealth Inc. are covered by the Canadian Investor Protection Fund.

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