Understanding the 2024 Canadian Federal Budget: Changes to the Capital Gains Inclusion Rate
The 2024 Canadian federal budget has introduced significant changes to the capital gains inclusion rate for both corporations and individuals. These adjustments, which became effective June 25, 2024, will impact how capital gains are taxed and require strategic tax planning to ensure the changes are properly managed.
What is the Capital Gains Inclusion Rate?
The capital gains inclusion rate is the percentage of a capital gain that is subject to taxation. In Canada, capital gains are profits realized from the sale of an asset, such as shares or real estate. Unlike other sources of income, such as employment or interest, which are fully included when adding up your taxable income, capital gains are only partially included. The goal here is to help incentivise investment in the economy by providing this tax incentive. The inclusion rate determines how much of a capital gain in a given year is added to a taxpayer's income.
For example, under the previous inclusion rate of 50%, if you sold an asset for a gain of $10,000, only $5,000 of that would be included in your taxable income. The new inclusion rate of 66.67% means that $6,667 of the $10,000 gain could now be taxable.
Key Changes for Corporations and Trusts
For corporations and most trusts, the capital gains inclusion rate will rise from 50% to 66.67% across the board. This means that a larger portion of any capital gains will now be subject to taxation. For instance, if a corporation realizes a capital gain of $300,000, $200,000 (two-thirds) will now be included in taxable income, compared to $150,000 previously. There are further complexities that occur when a Canadian private corporation earns passive income like a capital gain, such as the potential payment of refundable taxes, which are outside the scope of this article.
Key Changes for Individuals
For individuals, the changes are slightly more nuanced. The inclusion rate will increase similarly from 50% to 66.67%, but this applies only to the portion of capital gains that exceed an annual threshold of $250,000. Gains up to this threshold will continue to be taxed at the previous 50% inclusion rate.
For example, if an individual sells their cottage and realizes a total capital gain of $400,000 for the year, the first $250,000 will be taxed at the 50% inclusion rate, and the remaining $150,000 will be taxed at the 66.67% rate. This effectively increases the taxable amount from $200,000 to $225,000.
Lifetime Capital Gains Exemption (LCGE)
In a related change, the budget also increases the LCGE limit to $1.25 million from the previous limit of roughly $1 million. This exemption allows an individual taxpayer to shelter capital gains on the sale of qualified small business corporation shares, farm, and fishing property, up to the set limit. The CRA has provided the reasoning for this related change in their backgrounder:
In practice, the lifetime capital gains exemption is provided in the form of a deduction when calculating an individual's taxable income. As of January 1, 2024, the maximum lifetime deduction is $508,418 (i.e., $1,016,836 x the current ½ inclusion rate). Starting on June 25, 2024, the new maximum lifetime deduction would be $833,333 ($1,250,000 × ⅔) to reflect the new basic inclusion rate of two-thirds and the increased lifetime limit of $1.25 million.
Implications for Tax and Financial Planning
These changes necessitate a re-evaluation of investment strategies and tax planning. Individuals and corporations should consider the timing of their capital gains and explore options to mitigate the increased tax burden.
For instance, individuals should plan around the $250,000 threshold to maximize the benefits they can achieve by realizing gains at the lower inclusion rate of 50% going forward. Consulting with your tax advisor to navigate these changes and optimize your tax planning going forward is recommended due to the complexities involved with these new rules.
Additionally, changing the structure of your portfolios to target dividend income in your corporation and capital gains in personally held investment accounts may be an excellent strategy to help maintain access to the 50% inclusion rate.
Conclusion
The 2024 budget's increase to the capital gains inclusion rate represents a significant shift in the tax landscape for Canadian taxpayers. Both corporations and individuals will need to adapt their financial strategies to align with these new rules and minimize the additional tax that could otherwise result.
For more detailed advice and tailored tax planning, please feel free to reach out to the team at Clearpath Accounting!
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