Capital gains inclusion rate raised to 66.6% for high earners

The federal government is raising the inclusion rate to two-thirds from one-half on capital gains above $250,000 realized annually by individuals and on all capital gains realized by corporations and trusts.

The proposed higher new rate kicks in June 25, 2024, the government announced in Budget 2024.­

The inclusion rate for capital gains up to $250,000 realized annually by individuals will continue to be 50%.

“By increasing the capital gains inclusion rate, we will tackle one of the most regressive elements in Canada’s tax system,” the government said in the budget document. The current 50% inclusion rate on capital gains disproportionately benefits the wealthy, who earn relatively more income from capital gains compared to the middle class, the government said.

The government also proposed raising the lifetime capital gains exemption (LCGE) to apply to $1.25 million of capital gains, from $1,016,836 for 2024, to apply to dispositions on or after June 25, with indexation resuming in 2026.

And the government proposed a new Canadian Entrepreneurs’ Incentive, which would reduce the tax rate on capital gains on the disposition of qualifying shares of a small business corporation by an eligible individual.

The government’s proposed hike to the capital gains rate will lead investors in the coming weeks “to think about whether they want to accelerate their tax liability in order to pay less of it now than they might have to perhaps several years down the road,” said Brian Ernewein, senior advisor with KPMG LLP in Ottawa.

Jamie Golombek, managing director of tax and estate planning with CIBC Private Wealth in Toronto, said the proposed increase to the capital gains rate would apply to relatively few people.

“But for investors who regularly realize capital gains in a portfolio, this is now an opportunity to consider realizing a lot of gains before June 25 to take advantage of the guaranteed 50% inclusion rate on certain parts of a portfolio that make sense from an asset-allocation perspective,” Golombek said.

People who, say, sell a vacation property for which the principal residence exemption is not available, or a business, subject to the availability of the LCGE, may find themselves above the $250,000 threshold.

“It also provides a new opportunity for investors to consider whether or not, each year from now on, they want to realize $250,000 in gains purposefully to take advantage of the 50% rate rather that the two-thirds rate,” Golombek said.

Ernewein said investors who hold investments in a corporation will need to consider whether doing so still makes sense: “[There] would be an additional cost even on the first $250,000 of corporate gains,” relative to gains earned personally.

These investors will need to ask, “Is there some kind of way to get those investments out of the corporation without paying a great whack of tax?” Golombek said. “That’s the discussion [they] will need to have with their accountants and tax advisor to determine the cost of winding up that corporation ultimately and whether [the corporation] still makes sense.”

The proposed increase to the capital gains rate would generate $19.4 billion in tax revenue over five years, with the lion’s share — $6.9 billion — raised in the tax first year, the government estimated.

Ottawa is likely anticipating investors will push forward asset sales ahead of June 25 to recognize gains at the current 50% inclusion rate, Ernewein said: “That’s why you see a significant revenue pop for 2024–25.”

However, in its second and third years, the proposed measure would raise only an estimated $3.5 billion and $375 million, respectively. “Having sold earlier, [investors] are not going to be selling later,” Ernewein said.

In its fourth and fifth years, the measure will raise an estimated $3.7 billion and $5.1 billion, respectively, as the effects are fully absorbed and revenues return to a steady state, a Department of Finance official said.

The $250,000 threshold would effectively apply to capital gains realized by an individual, either directly or indirectly through a partnership or trust, net of any­ capital losses in the current year or from other years applied to reduce current-year capital gains.

The threshold would also apply net of any capital gains in respect of which the LCGE, the proposed employee ownership trust exemption or the proposed Canadian Entrepreneurs’ Incentive is claimed.

Transitional rules to account for two capital gains rates

For tax years that begin before and end on or after June 25, two 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 — that is, it would not be prorated — and would apply to net capital gains realized in Period 2.

“For 2024, the transition rules are going to make things pretty complicated for all the accountants out there that have been pretty frustrated with the trust reporting rules, and the underused housing tax rules, etc.,” Golombek said, referring to the uncertainty associated with those measures. “This is going to add a severe complication to the 2024 tax filing season, where in fact you have two periods — you need to track gains before and after a certain date.”

Claimants of the employee stock option deduction would be provided a one-third deduction of the taxable benefit to reflect the new capital gains inclusion rate, but would be entitled to a deduction of one-half 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.

The government said other amendments to legislation would be made to reflect the new inclusion rate, and additional details would be released in the coming months.