Wealth Strategies: Canada's Budget 2024 - Reshaping Capital Gains Inclusion Tax

The Canadian Federal Budget of 2024 introduced a significant shift in how capital gains are taxed. Previously, only half of capital gains were included in taxable income. This budget proposes an increase to the capital gains inclusion rate, affecting corporations, trusts, and individuals with large capital gains.

The core change involves raising the inclusion rate from half to two-thirds (66.67%) for all capital gains earned by corporations and trusts. For example, a corporation selling a property with a $100,000 capital gain would previously only see $50,000 added to its taxable income. Under the new rules, $66,667 would be included, increasing the corporation's overall tax liability by 33%.

Individuals will experience a similar increase, but with a crucial exemption. The inclusion rate of 66.67% only applies to the portion of their annual capital gains exceeding $250,000. Let's say an investor sells a stock portfolio with a $400,000 capital gain. The first $250,000 would still be taxed at the old 50% rate, resulting in $125,000 of taxable income. The remaining $150,000 would be subject to the new 66.67% rate, adding $100,000 to their taxable income. This threshold offers some relief for those with more modest capital gains.

The government justifies this change as a measure to promote tax fairness. Income earned through wages is taxed fully, and the budget aims to bring the taxation of capital gains closer to that standard. Consider a sales executive earning a salary of $200,000 a year. All of this income is taxed at their average tax rate based on provincial and federal income tax tiers. Previously, an investor earning the same amount through capital gains would only see half taxed. The new system aims to narrow this gap, particularly for high salaried employees.

More specifically and perhaps closer to home, here's an example of how much an Albertan in the highest tax bracket would pay in taxes under the new capital gains inclusion rate:

Scenario:

• An Alberta resident sells an investment and realizes a capital gain.
• They are in the highest tax bracket (over $355,845 in 2024) for both federal and provincial income tax.
• The capital gain is above $250,000. (The new inclusion rate only applies to the portion exceeding $250,000).

Old vs. New Capital Gains Tax (on the portion above $250,000):

Before June 25, 2024 (Old Rule):

• Only 50% of the capital gain is included in taxable income.
• Alberta top marginal tax rate is 15%.
• Federal top marginal tax rate is 33%.
• Combined top marginal tax rate on capital gains: (15% + 33%) x 50% = 24%

After June 25, 2024 (New Rule):

• 66.67% of the capital gain is included in taxable income (2/3).
• Combined top marginal tax rate on capital gains portion above $250,000: (15% + 33%) x 66.67% = 32%

Tax Increase:

• This Albertan would pay an additional 8% tax on the portion of the capital gain exceeding $250,000.

However, the budget acknowledges the importance of fostering entrepreneurship. To mitigate the impact on business owners, the Canadian Entrepreneurs' Incentive was introduced. This incentive proposes a lower, one-third (33.33%) inclusion rate for a lifetime maximum of $2 million of qualifying capital gains earned by entrepreneurs. Imagine a business owner selling their company for a $5 million capital gain. Under the new rules, the first $2 million would benefit from the entrepreneur's incentive, resulting in a lower tax burden. The remaining $3 million would be taxed at the standard 66.67% rate. This benefit will be phased in gradually over the next decade. It is also important to note that the incentive excludes: Professional Corporations, Financial and Insurance Services, Food and Accommodation Services, Arts, Recreation, and Entertainment Services, Personal Care Services, and Consulting Services.

This incentive is separate from the Lifetime Capital Gains Exemption (LCGE) which shelters a portion of your capital gains from taxes when selling qualified small business corporation shares or qualified farm or fishing property. Budget 2024 increased the LCGE limit to $1.25 million (from current $1,016,836) for dispositions that occur on or after June 25, 2024.

In conclusion, the 2024 budget increases the capital gains inclusion rate for taxpayers. This change aims to create a fairer tax system by aligning the taxation of capital gains with income from other sources. However, the Canadian Entrepreneurs' Incentive offers some mitigation for those selling businesses, aiming to foster a strong entrepreneurial environment. The long-term effect of these changes will depend on how they affect investment decisions and business activity in Canada.

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Disclosure: Any commentaries, reports or other content are provided for your information only and are not considered investment advice. Readers should not act on this information without first consulting Milestone, their investment advisor, tax advisor, financial planner or lawyer. This communication is intended for Canadian residents only and does not constitute as an offer or solicitation by anyone in any jurisdiction in which such an offer is not allowed.