Update to Capital Gains Inclusion Rates

On June 10, 2024, the government tabled a Notice of Ways and Means Motion (NWMM) that contained the much-anticipated tax legislation outlining the changes to capital gains inclusion rates (CGIR) and associated stock option benefit deduction rates announced in the Federal Budget (Budget 2024) on April 16.

The NWMM Confirmed:

• Effective date for the CGIR changes will be June 25, 2024. Many Canadian tax practitioners were wondering if an election would be made available, if grandfathering provisions would be provided for sale transactions negotiated prior to the Budget Day and are slated to close post June 25, or if the date for the CGIR changes would be extended to December 31 to align with most Canadian tax reporting. Canadian personal, corporate and trust taxpayers impacted by the CGIR changes should reach out to their financial and tax professionals to discuss whether their accrued capital gains should be crystallized or eligible stock options exercised prior to June 25. Please refer to our Planning for Changes to Taxation of Capital Gains for background and strategy considerations.
• Donations of stock options. Stock options will be eligible for a 2/3 deduction to effectively eliminate the stock option benefit on donated stock options subject to the lower 1/3 deduction rate.
• Allowable business investment losses (ABIL). ABILs realized from bad debts and bankrupt small business corporations will increase from one half to two thirds for losses realized on or after June 25, 2024.

What Changed:

• New relief for specific trusts. Graduated Rate Estates (GREs) and Qualified Disability Trusts (QDTs) will be now eligible for the $250,000 threshold in respect of capital gains that are not allocated to a trust beneficiary in the year. This change aligns with the concept that these trusts are subject to the same graduated rate structure as personal income taxes. Other trusts, such as family trusts, alter-ego trusts, joint spousal trusts, and testamentary trusts that no longer qualify as GREs will not be entitled to the $250,000 threshold.
• Trust designations to beneficiaries. The notice clarifies that for the 2024 tax year, a trust can allocate the capital gains between Period 1 (pre-June 25th) and Period 2 (post-June 24th) based on the date the trust realized the capital gain. It is expected that the T3 tax slip will be amended to communicate capital gains distributed between the two time periods. If a trust does not disclose the period information, capital gains distributed are deemed to have been realized after June 24, 2024.
• Mutual fund trusts, mutual fund corporations, and segregated funds may follow the period rules like personal trusts, but they have the option of electing the deemed capital gains to be allocated to investors proportionally with the two periods based on the number of days in each period.
• Partnerships must allocate realized capital gains between the two time periods similar to trusts, not prorated like mutual funds. Investors should keep in mind they have no control over these capital gain allocations.
• Non-resident dispositions of Canadian real estate. The government will be raising the non-resident withholding tax rate from 25 per cent to 35 per cent to reflect the higher capital gains inclusion rate on non-resident dispositions of taxable Canadian property. The higher withholding rate is applicable to dispositions on or after January 1, 2025.

Additional Considerations:

• Choosing between stock options and capital gains. An individual taxpayer has one $250,000 threshold for the combination of capital gains and employee stock option benefits in a given tax year to be eligible for the 50 per cent capital gains inclusion and 50 per cent stock option deduction. The government has clarified that the individual may decide the allocation of the $250,000 threshold between capital gains and stock options. Note stock option income creates RRSP contribution room, and realized capital gains does not.
• Clarification on capital gains reserves timing. Taxpayers bringing a reserve into income from a prior year capital gain will report the capital gain at the inclusion rate applicable for that tax year. For taxation years that include June 25, 2024, the amount of the capital gain that is brought out of reserve will be deemed to be a capital gain of the taxpayer on the first day of the taxpayer’s taxation year. This clarification provides some flexibility to taxpayers in the decision to recognize all or a portion of the remaining reserve prior to June 25, 2024 to take advantage of the 50 per cent inclusion rate rather than deferring the reserve at a possibly higher inclusion rate.

Given the NWMM did not fundamentally changed the Budget 2024 CGIR proposals, taxpayers with significant unrealized gains should review their portfolios as soon as possible with their financial and tax professionals. Part of the decision whether to realize capital gains and pay the related income taxes prior to June 24 is determining the breakeven time horizon. This is the number of years that the forgone tax funds would have been invested to make up for the increased taxation on the gains. Taxpayers with shortened time horizons such as individuals nearing life expectancy, employees with expiring stock options, and trusts nearing the 21-year anniversary should be especially engaged in this analysis. Our financial advisors and our team of tax professionals can estimate the breakeven time horizon to help you with your decision to realize or not realize capital gains with the objective of maximizing your after-tax wealth.

In final, please note June 21 is the last day to settle trades before the June 25 effective date.

For further details on these announcements, refer to the Department of Finance’s website:

Capital Gains Inclusion Rate / French: https://www.canada.ca/fr/ministere-finances/nouvelles/2024/06/taux-dinclusion-des-gains-en-capital.html

Notice of Ways and Means Motion / French: https://fin.canada.ca/drleg-apl/2024/nwmm-amvm-0624-fra.html