Effective June 25, 2024, significant changes to the capital gains tax rules came into effect in Canada. As a business owner, it’s essential to understand these changes and how they may affect your individual or corporate taxation planning and investment strategies. In this blog, I explain the new capital gains changes and some incentives that can help you navigate them effectively.
What Are Capital Gains?
Let’s start with the basics. Capital gains refer to the profit you make from selling an asset or investment at a higher price than what you paid for it. For example, if you bought a cottage for $400,000 and sold it two years later for $500,000, you would have realized a capital gain of $100,000. Conversely, if you sell an asset for less than what you paid for it, you incur a capital loss.
You can realize capital gains or losses on various types of investments and assets, such as stocks, bonds, mutual fund shares, income properties, cottages, and even business equipment. However, capital gains and losses do not apply to your main residence.
Old vs. New Capital Gains Inclusion Rate
In the recent 2024 Federal Budget, Canada’s Finance Minister Chrystia Freeland announced important changes to the capital gains inclusion rate.
Under the previous rules, the capital gains inclusion rate was 50% for individuals, corporations and trusts. In other words, if you realized a capital gain of $100,000 as an individual, only $50,000 was added to your taxable income for the year.
As of June 25, 2024, the capital gains inclusion rate for corporations and trusts increased from 50% to 66.67%. For individuals, the inclusion rate on capital gains has also increased from 50% to 66.67%, but only on the portion exceeding $250,000. For capital gains under $250,000, the capital gains inclusion rate remains at 50%.
In short:
- For corporations and trusts, the capital gains tax inclusion rate has increased from 50% to 66.67%.
- For individuals with capital gains exceeding $250,000, the capital gains tax inclusion rate for the amount surpassing $250,000 has also been increased from 50% to 66.67%.
- For individuals with capital gains under $250,000, the capital gains tax inclusion rate remains unchanged at 50%.
Example of a capital gain for an individual in 2024:
Sarah generates a capital gain of $600,000 on June 1, 2024, prior to the effective date of the new capital gains inclusion rate. On July 25, 2024, Sarah realizes a capital loss of $75,000, and on October 1, 2024, a capital gain of $475,000.
- Before June 25, 2024, Sarah had a capital gain of $600,000, to which the one-half inclusion rate applies, resulting in a taxable capital gain of $300,000.
- Sarah had a net capital gain of $400,000 after June 25th. A one-half inclusion rate applies to the first $250,000, and a two-thirds inclusion rate applies to the remaining $150,000, resulting in a taxable capital gain of $225,000.
- Sarah’s total taxable capital gain for the 2024 tax year would be $525,000.
Now, let’s take a closer look at the impacts on business owners and corporations.
Impact on Business Owners
The increased inclusion rate significantly impacts small and medium-sized businesses. For instance, if you sell business assets or investments and realize significant capital gains, a larger portion of those gains will now be subject to taxation. This change could influence your decisions regarding the sales of some assets and the structure of business transactions.
Additionally, the rise in the inclusion rate could also affect your succession when it comes to transferring your wealth. Although there is no estate tax in Canada, capital gains are realized at the time of death on the value of real estate, a cottage, or investments, for example. This means that the heirs of your estate could face higher tax liabilities due to the increased inclusion rate.
Effects on Corporations
Corporations are definitively the most impacted by the new inclusion rate on capital gains. Previously, corporations only had to include 50% of their capital gains in taxable income. As of June 25, 2024, this rate has increased to 66.67%. This means that if your corporation realizes a gain of $100,000, $66,670 will now be included in taxable income instead of $50,000.
Here are some specific impacts on your corporation:
- Increased Tax Burden: Your corporation will face a higher tax burden on capital gains, which could affect your investment strategies and decisions.
- Investment Planning: As a corporation, you may need to reassess your investment portfolio and the timing of asset sales to manage the increased tax liability effectively.
- Cash Flow Management: The higher inclusion rate could impact your corporation’s cash flow, especially if significant capital gains are realized. Proper planning and strategic management will be crucial to mitigate these effects.
- Strategic Asset Disposition: Your corporation may consider deferring the sale of assets or restructuring transactions to optimize tax outcomes under the new rules.
But that’s not all.
Other Changes Impacting Capital Gains & Tax Planning
In addition to changes to the capital gains inclusion rate, the latest federal budget also included other measures, this time positive for some entrepreneurs, impacting capital gains taxation. These include adjustments to the lifetime capital gains exemption (LCGE) and the introduction of the Canadian Entrepreneur Incentive (CEI), two measures designed to provide significant tax relief and support business growth.
Changes in the Lifetime Capital Gains Exemption (LCGE)
The Lifetime Capital Gains Exemption (LCGE) is not new. First introduced in 1986, LCGE is designed to support entrepreneurial growth and succession planning by providing significant tax savings for Canadian small business owners, farmers, and fishers. It helps business owners like you retain more of their profits when they sell their enterprises, facilitating reinvestment or retirement planning.
As of June 25, 2024, the LCGE has increased to $1.25 million, up from the previous limit of approximately $1.017 million. This exemption allows individuals to realize capital gains on the sale of qualifying small business shares, farm properties, or fishing properties without being taxed up to the exemption limit. Additionally, starting in 2026, the exemption amount will be indexed to inflation, ensuring its value keeps pace with economic changes.
By leveraging the LCGE, business owners can reduce their taxable income, making it an essential tool for effective financial and tax planning in Canada.
The New Canadian Entrepreneurs’ Incentive (CEI)
The Canadian Entrepreneurs’ Incentive (CEI), introduced in the 2024 budget, offers substantial tax relief to business owners. This incentive is designed to encourage innovative entrepreneurs in the research and start-up phase to develop their businesses, particularly in the technology and manufacturing sectors.
The CEI reduces the capital gains inclusion rate to one-third (33.3%) for up to $2 million in lifetime gains on qualifying small business shares. This limit phases in gradually, starting at $200,000 annually from January 1, 2025, and reaching $2 million by January 1, 2034.
To be eligible, shares must be part of a Canadian-Controlled Private Corporation (CCPC) and held for at least five years, with active engagement in the business. The CEI, complementing the Lifetime Capital Gains Exemption (LCGE), allows business owners to significantly reduce their taxable gains, fostering long-term investment and growth in the entrepreneurial sector. This incentive provides a crucial tax advantage for those planning to sell their small business shares.
What Are The Next Steps?
The changes to the capital gains tax rules in Canada’s 2024 budget are significant, especially for business owners, investors, and corporations. Given these changes, I strongly recommend (if you haven’t already done so) reviewing your tax planning strategies and investment strategies with your strategic wealth advisors and their team of tax and accounting experts. Despite the increase in the inclusion rate on capital gains, you could benefit from significant tax reductions thanks to the Lifetime Capital Gains Exemption (LCGE) and the Canadian Entrepreneur Incentive (CEI). Capital loss management and the new deductions for employee stock options are also valuable strategies to understand and take advantage of.
For tailored advice and to develop a strategy that best suits your situation, I invite you to consult with your strategic wealth advisor from the St-Georges Group. Being proactive in your wealth management and financial planning can help you navigate these changes effectively and ensure that your business and investments remain optimized for tax-sheltered growth and profitability.
About Valérie Forget
Valérie has been an integral part of the St-Georges Group since 2019, with her affiliation to the Assante wealth management family beginning in 2015. She earned her Bachelor in Finance from the Université du Québec en Outaouais in 2016, and is now obtaining her financial planning designation (Pl. Fin.). Further bolstering her financial expertise, Valérie completed courses from the Canadian Securities Institute, ensuring she stays updated with the latest financial trends and strategies. Valérie excels in conducting detailed financial analyses and calculations. Her approach is centered on understanding clients’ unique financial landscapes and offering adaptive wealth management solutions tailored to their evolving needs.
See Valérie’s full bio on the team page and follow Valérie on LinkedIn.
