Navigating Uncertainty: The Future of the Capital Gains Inclusion Rate in Canada

The Political Landscape: A Changing Alliance

In recent years, Canada’s political landscape has been shaped by the alliance between the Liberal government and the New Democratic Party (NDP). This collaboration has allowed the Liberal minority government to pass key legislation, but recent signs suggest that the alliance is dissolving. With the NDP potentially withdrawing its support, the Liberals may face challenges in passing new policies, including proposed changes to the capital gains inclusion rate—a topic of concern for many Canadians. A topic on the floor of the House of Commons currently.

Capital Gains Inclusion Rate: What’s Changing?

The capital gains inclusion rate determines how much of a realized capital gain is taxable. Currently, 50% of any capital gain is subject to tax at your marginal tax rate. However, as part of Budget 2024, the government has proposed increasing the inclusion rate to 66.67% for capital gains exceeding $250,000 per year. For individuals, the first $250,000 in capital gains will still be taxed at the current 50% rate, but anything above that will be subject to the higher inclusion rate​. The parliamentary budget officer says the increase to the capital gains inclusion rate will bring in $17.4 billion in revenue over five years.

This nuanced approach means that for many Canadians, the impact of this change may be minimal unless their capital gains exceed this threshold.

Let’s explore what this could mean for different groups:

1. Early Savers: Starting Off Right

For early savers, this change might not pose a significant concern, as it only impacts capital gains exceeding $250,000. However, understanding the potential for future tax increases is important. By focusing on tax-efficient investment strategies, such as using registered accounts like TFSAs (Tax-Free Savings Accounts), where capital gains are not taxed, early savers can protect their long-term wealth-building strategies.

Tip: Maximize your contributions to tax-sheltered accounts like TFSAs to shield investment growth from potential future tax increases.

1. Business Owners: Planning for Growth and Exit

For business owners, selling a business may trigger substantial capital gains. With the proposed changes, the portion of capital gains exceeding $250,000 would face the increased inclusion rate, potentially reducing the net proceeds from the sale.

Tip: Business owners should work with financial advisors to explore strategies such as utilizing the lifetime capital gains exemption to minimize taxes, section 85 rollover, using a holding company structure, or sale through an earn-out provision.

Impact Example: If a business owner sells their business for a $1,000,000 gain, the first $250,000 would still be taxed at the 50% inclusion rate, but the remaining $750,000 would be taxed at the new 66.67% rate. This would increase the total tax burden significantly, especially for high-income earners.

1. Pre-Retirees: Protecting Your Nest Egg

For those nearing retirement, a higher inclusion rate could reduce the value of non-registered investments. The potential for increased taxes may impact the decisions around when to sell assets and realize gains.

Tip: Pre-retirees should consult with their advisors to assess their portfolios and consider realizing gains before the June 2024 deadline to benefit from the lower inclusion rate.

Tip: Beware the Superficial Loss Rule. If you sell a stock and incur a capital loss, you cannot repurchase that stock (or a substantially identical one) within 30 days, or the loss will be considered a superficial loss. The loss will then be denied for tax purposes but added back to the adjusted cost base (ACB) of the repurchased stock.

1. Selling the Family Cottage: Planning for Tax Implications

For many families, the sale of a cottage or vacation home can trigger significant capital gains. Since the family cottage is not considered a primary residence, it does not qualify for the principal residence exemption, meaning that the entire gain from the sale is subject to capital gains tax. Under the proposed changes, only the first $250,000 of the gain would be taxed at the current 50% inclusion rate, while any gain exceeding that would be taxed at the higher 66.67% rate starting on June 25, 2024.

This change could substantially increase the tax burden for families looking to sell their cottage. Families should consider planning in advance, perhaps by transferring ownership to the next generation or using other tax-deferral strategies, to minimize the potential tax hit. These options allow you to manage the tax impact while keeping the cottage in the family:

• Gift or Transfer to Children During Your Lifetime

• Use of a Family Trust

• Gradual Ownership Changes Over Time

• Principal Residence Exemption for Partial Ownership

• Sell to Children at Fair Market Value with a Promissory Note

1. Retirees: Managing Withdrawals and Legacy Planning

Retirees relying on investment withdrawals may see more of their gains taxed if they exceed the $250,000 threshold. This could also affect legacy planning, as higher taxes could reduce the value of assets passed to heirs.

Tip: Consider estate planning tools, such as trusts, or insurance, to manage the tax burden on future generations.

RRSP Withdrawals: Separate From Capital Gains Changes

Changes to the capital gains inclusion rate do not impact Registered Retirement Savings Plan (RRSP) withdrawals, as RRSP withdrawals are taxed as regular income. Whether or not the inclusion rate increases, 100% of RRSP withdrawals are added to your taxable income and taxed at your marginal rate.

How RRSP Withdrawals Are Taxed:

1. Contributions and Growth: Contributions to an RRSP are tax-deferred, and investment growth is sheltered from taxes until withdrawal.

2. Withdrawals: When you withdraw from an RRSP, the entire amount is taxed as regular income, not at the capital gains rate.

Key Takeaway: While the capital gains inclusion rate change does not affect RRSP withdrawals directly, it is essential to consider non-registered investment strategies in light of these potential changes.

What’s Next?

No changes have been implemented yet, but Canadians should stay informed. The potential increase in the inclusion rate reminds us of the importance of proactive financial planning, especially for those with significant capital gains.

Conclusion

The evolving political situation has introduced uncertainty regarding Canada’s tax landscape. While the dissolution of the NDP-Liberal alliance and the proposed changes to the capital gains inclusion rate may be concerning, staying informed and taking a proactive approach to financial planning can help Canadians navigate these potential changes. By understanding how these changes might impact your unique situation, you can make informed decisions and secure your financial future.

Take Control of Your Financial Future

If you'd like to discuss how to optimize your financial plan in light of these potential changes, book a call with us today. Together, we can create a strategy tailored to your needs and help you achieve your financial goals.