2024 Federal budget

Introduction

On April 16, 2024, Deputy Prime Minister and Minister of Finance, Chrystia Freeland, presented Budget 2024. For a summary of tax measures announced, please refer to our newsletter dated April 17, 2024 here: https://www.dhgroup.ca/2024/04/17/2024-federal-budget-summary/. 

The Budget proposes to increase the capital gains inclusion rate from ½ to ⅔ for certain capital gains realized on or after June 25, 2024. There may be planning strategies that you may wish to consider before June 25, 2024 to take advantage of the current ½ inclusion rate. 

Proposed Changes related to capital gains

The Government has not released the draft legislation yet, so we don’t have all the information we need to advise our clients on the best approach in all circumstances. The Minister of Finance has stated that the draft legislation will be released in June, which will make it challenging for all Canadians to understand the rules and take any steps before June 25, 2024 to plan to efficiently address the proposed changes.

Capital Gains Inclusion Rate

Budget 2024 proposes to increase the capital gains inclusion rate from ½ to ⅔ for corporations and trusts, and from ½ to ⅔ on the portion of capital gains realized in the year that exceed $250,000 for individuals, for capital gains realized on or after June 25, 2024.

The $250,000 threshold would effectively apply to capital gains realized by an individual, either directly or indirectly via a partnership or trust, net of any:

• current-year capital losses;
• capital losses of other years applied to reduce current-year capital gains; 

and

• capital gains in respect of which the Lifetime Capital Gains Exemption (LCGE), the proposed Employee Ownership Trust (EOT) Exemption or the proposed Canadian Entrepreneurs’ Incentive is claimed.

Claimants of the employee stock option deduction would be provided a ⅓ deduction of the taxable benefit to reflect the new capital gains inclusion rate but would be entitled to a deduction of ½ the taxable benefit up to a combined limit of $250,000 for both employee stock options and capital gains.

Net capital losses of prior years would continue to be deductible against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset. This means that a capital loss realized prior to the rate change would fully offset an equivalent capital gain realized after the rate change.

For tax years that begin before and end on or after June 25, 2024, two different inclusion rates would apply. As a result, transitional rules would be required to separately identify capital gains and losses realized before the effective date (Period 1) and those realized on or after the effective date (Period 2).

The annual $250,000 threshold for individuals would be fully available in 2024 (i.e., it would not be prorated) and would apply only in respect of net capital gains realized in Period 2.

Lifetime Capital Gains Exemption

Budget 2024 proposes to increase the LCGE to apply to up to $1.25 million of eligible capital gains on the disposition of shares of qualified small business corporation.

This measure would apply to dispositions that occur on or after June 25, 2024. Indexation of the LCGE, which results in annual increases (based on the inflation rate) to the amount eligible for the exemption, would resume in 2026.

Canadian Entrepreneurs’ Incentive

Budget 2024 proposes to introduce the Canadian Entrepreneurs’ Incentive. This incentive would reduce the inclusion rate on capital gains on the disposition of qualifying shares by an eligible individual. Specifically, this incentive would provide for a capital gains inclusion rate that is one half the prevailing inclusion rate, on up to $2 million in capital gains per individual over their lifetime.

The lifetime limit would be phased in by increments of $200,000 per year, beginning on January 1, 2025, before ultimately reaching a value of $2 million by January 1, 2034.

Under the ⅔ capital gains inclusion rate proposed in Budget 2024, this measure would result in an inclusion rate of ⅓ for qualifying dispositions. This measure would apply in addition to any available capital gains exemption.

This measure would apply to dispositions that occur on or after January 1, 2025. For more details on the criteria for qualifying shares, please refer to our newsletter dated April 17, 2024.  

Who is affected

The proposed increase to the capital gains inclusion rate from ½ to ⅔ may affect individuals, corporations, trusts, and members of partnerships, with the following transactions or circumstances that may generate capital gains:

• Transactions expected to complete or close on or after June 25, 2024;
• For partnerships and trusts, transactions that are expected to complete or close after a taxation year-ended June 24, 2024;
• An expectation to sell a business or asset(s) in the near future, especially within the next 1-2 years, or potentially within the next decade.
• Potential deemed disposition on death for an individual or a trust such as alter ego trust and joint spousal trust in the near future.
• Deemed disposition on emigration in the near future.
• Previously claimed capital gains reserve that is expected to be realized in future years starting on or after June 25, 2024.
• Employees with stock option benefits and entitled to stock option deduction; and
• Donations of assets such as publicly traded securities on or after June 25, 2024. 

Planning strategies

There are several planning strategies that could be considered to take advantage of the current capital gains inclusion rate of 1/2:

• Move or trigger the completion or closing date of pending transactions on or before June 24, 2024;
• Consider selling capital property to third parties on or before June 24, 2024;
• Crystallize accrued gains for income tax purposes on currently held capital properties (which does not usually require a sale to unrelated parties); and
• Consider estate, succession and/or charitable donations planning to minimize future capital gains taxes on deemed disposition on death;

Most, if not all, of the strategies should be implemented prior to June 25, 2024 before the effective date of the increased capital gains inclusion rate. Generally speaking, that will require tax planning and perhaps legal advice well before June 24, 2024 to properly implement and document the strategies. 

Sample of the Analysis Required

The issue to be analyzed is whether it is better to realize a capital gain before June 25, 2024 and to pay the tax for the current tax year (at what might be a lower tax rate) or to defer the realization of the gain to a future tax year and benefit from the growth of the funds invested that would otherwise be used to pay the tax this year. This can be illustrated in an example:

• Maria owns 100,000 shares of PublicCo Ltd., a publicly traded company. 
• Maria acquired the shares of PublicCo Ltd. for $250,000, and the current fair market value of the shares is $750,000.
• If Maria sold the shares today, she would realize a capital gain of ($750,000 – $250,000) $500,000. 
• Since Maria has regular annual income from salary, interest, and dividends that are in excess of $250,000, she expects to be in the top marginal tax bracket for the foreseeable future.
• Maria also expects to exceed her annual personal capital gains threshold of $250,000 from other sources of investments.
• Maria can invest in a GIC that earns 3% interest after tax. 

Scenario 1: Disposition expected in the near future

Assume that Maria thinks that the value of the shares of PublicCo Ltd. has peaked, and she wants to sell the shares this autumn to pay off her mortgage before it needs to be renewed (at a much higher interest rate) this November. 

In this scenario, Maria is certain that she wants to sell the shares this year. Accordingly, it would be prudent for Maria to sell the shares of PublicCo Ltd. by June 20, 2024 (to make sure that the trade settles on or before June 24, 2025) to avoid a portion of her capital gain being taxed at the new higher inclusion rate:

Table 1	Pre-June 25	Post June 24	Difference
Sale proceeds	750,000	750,000	–
Cost base	(250,000)	(250,000)	–
Capital gain	500,000	500,000	–
Inclusion rate	50%	66.67%	16.67%
Taxable capital gain	250,000	333,333	83,333
Marginal tax rate	53.50%	53.50%	53.50%
Tax payable	133,750	178,333	44,583

Maria would save $44,583 in tax by selling the shares before June 25, 2024. 

Scenario 2: Disposition expected in the mid-term.

Assume that Maria thinks that the value of the shares of PublicCo Ltd. has not yet peaked, and she wants to sell the shares in May of 2026 to pay off her mortgage when it matures in June of 2026. 

Maria has a choice: 

1. she can crystallize her gain before June 25, 2024 to lock in the old capital gains inclusion rate and then repurchase the shares with the after-tax funds available; or 
2. wait two years to sell the sell the shares and pay tax at the higher tax rate. 

If Maria crystallizes her gain before June 25, 2024, she will owe $133,750 of income tax in April of 2025 instead of owing $178,333 in April of 2027 (please see Table 1 above for calculations).

The question for Maria is whether it is better to pay tax of $133,750 now than to pay $178,333 in two years. In this case, the present value of the $133,750 owing in April 2025 vs. the present value of the $178,333 owing in April of 2027 indicates that crystallizing now is better:

• If Maria crystallized the gain before June 25, she needs to set aside approximately $130,000 today in a GIC at a 3% after-tax rate to have $133,750 in April 2025 to pay the tax owing.  
• If Maria realizes the gain in 2026, she needs to set aside approximately $168,000 today in a GIC at a 3% after-tax rate to have $178,333 in April 2027 to pay the tax owing.  

In this case, crystallizing the gain before June 25, 2024 has a tax cost with a lower net present value than realizing the gain in 2026. Accordingly, it would be prudent for Maria to sell the shares of PublicCo Ltd. by June 20, 2024 (to make sure that the trade settles on or before June 24, 2025) to avoid a portion of her capital gain being taxed at the new higher inclusion rate.  

Scenario 3: Long holding period

Assume that Maria thinks that the PublicCo Ltd. shares are a great long term investment, and she has no plans to sell the shares for at least fifteen years (or more). 

Maria has a choice: she can crystallize her gain before June 25, 2024 to lock in the old capital gains inclusion rate and then buy back the shares with the after-tax funds available or wait ten years (or more) to sell the sell the shares and pay tax at the higher tax rate. If she sells now, she will owe $133,750 of income tax in April of 2025 instead of owing $178,333 in April of 2040 (please see Table 1 above for calculations).

The question for Maria is whether it is better to pay $133,750 of tax now than to pay $178,333 in 15 years. In this case, the present value of the $133,750 owing in April 2025 vs. the present value of the $178,333 owing in April of 2040 indicates that waiting to crystallize is better:

• If Maria crystallized the gain before June 25, she needs to set aside approximately $130,000 today in a GIC at a 3% after-tax rate to have $133,750 in April 2025 to pay the tax owing.  
• If Maria realizes the gain in 2039, she needs to set aside approximately $115,000 today in a GIC at a 3% after-tax rate to have $178,333 in April 2040 to pay the tax owing.  

In this case, crystallizing the gain before June 25, 2024 has a tax cost with a higher net present value than realizing the gain in 2039. Accordingly, it would not be prudent for Maria to sell the shares of PublicCo Ltd. by June 24, 2024.

Please reach out to your D&H Group LLP advisor as soon as possible if you have any questions or would like to discuss how the increased inclusion rate will impact your specific tax situation. 

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