The 2024 Federal Budget was released on April 16th, and proposed a few key changes that will impact Canadians, and especially small business owners across Canada. While a number of changes have been announced, we will focus on the main items that impact TPC Financial Group clients and Canadian small business owners.
Change to Capital Gains Inclusion Rate
The most impactful change for TPC Financial Group clients, and small business owners across Canada was an increase to the capital gains inclusion rate.
As a refresher, the capital gains inclusion rate represents the portion of gains that would be subject to taxation at marginal tax rates.
The current capital gains inclusion rate is 50%, and the proposed change would have the inclusion rate increase from 50% to 66.67% on gains surpassing $250,000/year for individuals. The current inclusion rate of 50% would apply for annual capital gains under $250,000.
For corporations and trusts, the $250,000 annual threshold does not apply. An inclusion rate of 66.67% will apply for all capital gains realized after June 25th, 2024.
The budget also noted intentions to make other consequential amendments to reflect the new inclusion rate and stated that additional details will be released shortly.
Analysis
This represents a further change to Canadian business owners who have invested under the framework set forth by past administrations. In addition to seeing an increased inclusion rate on realized capital gains, which results in additional corporate taxation on certain dispositions, it will also see a knock-on effect on other areas of taxation.
With an increased inclusion rate on taxable capital gains, when capital gains are realized inside a corporation, the $50,000 passive income threshold may be reached sooner resulting in business owners potentially paying increased taxes on active income due to a reduction in their small business limit.
The tax-free portion of a capital gain can be withdrawn from a corporation tax-free upon filing a capital dividend election with the CRA. Currently, this allows for 50% of a gain to be withdrawn to the individual shareholders on a tax-free basis. Under the proposed changes, only 33.33% will be available as a tax-free capital dividend.
Furthermore, ETF’s and mutual funds will also be subject to the new inclusion rates. The net returns passed on to investors will see additional taxation which will ultimately erode ongoing returns.
Finally, while the majority of Canadians will not realize capital gains in excess of $250,000 in any given year, many Canadians are likely to be impacted when capital gains are realized on death. While this is not overtly classified as a “death tax”, it is important to remember that capital gains must be realized on the deceased’s terminal return in the year that they die. While annual gains can potentially be maintained below that $250,000 threshold, the opportunities for estate planning may be limited. CPA Canada has estimated that approximately $1 trillion is set to be transferred between Canadian baby boomers to their children between 2023 and 2026. It appears as though the current government is hoping to tap into these transfers to help fund their spending.
Recommendations
We have received a flood of inquiries from clients and non-clients alike, asking how these changes will impact their long-term investment strategies.
Depending on a client’s circumstances, these changes may warrant some additional planning for those who hold significant gains within a corporation or trust. There are potential opportunities to crystallize gains prior to the June 25th implementation date to take advantage of the current framework. This would allow a larger tax-free capital dividend and would also reduce corporate taxation when compared to selling under the post-June 25th framework.
Alternatively, it may be difficult to justify incurring taxation now to avoid paying slightly more tax in the future. As an example, paying $25 in tax now to avoid $33.33 tax in 10 years may not be a prudent strategy, when the alternative is to leave that $25 invested and allow it to grow over time.
For those who have concentrated unrealized losses amongst a few positions, there may be opportunities to crystalize gains, claim a tax-free capital dividend (at 50%), and then offset any taxes by selling an equal amount of unrealized losses.
For clients of TPC Financial, we will be reviewing each specific situation to determine whether proactive planning should take place prior to June 25th.
Moving forward, our analysis shows tax deferral through incorporation and corporate investments to still be an optimal strategy to complement other registered investment vehicles. These changes to the inclusion rate have no impact on the taxation of Canadian dividends, which still allows for a tax-efficient way to generate passive income that will fund your retirement lifestyle.
While broader decisions regarding annual compensation and overall allocation between income and growth strategies are likely to see ongoing adjustments, the recent changes are not likely to warrant dramatic and immediate changes to long-term strategy.
Increased Lifetime Capital Gains Exemption
For those hoping to sell a qualifying small business, this budget proposes an increase to the Lifetime Capital Gains Exemption (LCGE) from $1,016,836 for 2024 up to $1,250,000. This increased limit would apply to transactions on or after June 25th, 2024.
For clients looking to sell a business in the immediate future, the benefits of an enhanced LCGE will need to be weighed against the increase to the capital gains inclusion rate to determine whether there is an advantage to closing any deal prior to the June 25th implementation.
Increase to RRSP Homebuyers Plan
This budget increases the withdrawal limit for the RRSP Homebuyers plan from $35,000 to $60,000 for all withdrawals made after April 16th, 2024.
A temporary extension was announced that would defer the start of the 15-year repayment period from 2 years to 5 years following the withdrawal date.
Our office will be sending a separate newsletter with respect to these housing changes and how they impact our clients, and Canadians in general.
Conclusion & Looking Forward
These changes have sparked much debate amongst the financial community, and for those who are incorporated this recent change will be a factor in long-term financial planning strategies.
For those who work with TPC Financial Group, feel free to reach out to your financial planner if you have any specific questions with respect to this budget and how it affects your unique situation.
If you are not currently a TPC Financial Group client but wish to have a complimentary discussion with a member of our financial advisory team, feel free to reach out.
TPC Financial Group will endeavour to keep everyone up-to-date on any changes moving forward and will continue to be a resource for those who have any questions as new information is released.