Part II – Capital gains inclusion rate

Capital Dividend Account

Initial proposals in the Notice of Ways and Means Motion (“NWMM”) of June 10, 2024, addressed the change in the capital gains inclusion rate by creating a blended inclusion rate for the transition year. This inadvertently created an issue with the calculation of the Capital Dividend Account as the blended inclusion rate could result in overpayment of capital dividends, as it could not be calculated until the end of the year, where the calculation of the Capital Dividend Account is normally a point-in-time test.

Intending to remedy this issue, a new paragraph was added to address this by deeming for the purposes of the computation of the Capital Dividend Account, that the inclusion rate used on capital gains and losses in the transitional year should be:

• 1/2, if the disposition occurred before June 25, 2024, or
• 2/3, if the disposition occurred after June 24, 2024.

This creates certainty for payments made throughout the transition year. It is important to consider paying out your Capital Dividend Account balance in 2023 if you had significant gains prior to June 25, 2024.

At the end of the transition year, the Capital Dividend Account will be recalculated based on the corporation’s inclusion rate for the year to ensure consistency with the capital gains inclusion rate blended rate. This will affect the yearend and opening balances of companies in their first yearend beginning on or after June 25, 2024.

Employee stock options

The draft legislation included changes to the stock option deduction to reflect the new inclusion rate. 

Alternative Minimum Tax

Budget 2024 proposed amendments to the initial release of draft legislation from August 2023. Key amendments (effective as at Jan. 1, 2024) were:

• Increase charitable donations to be deducted at 80 per cent, up from 40 per cent.
• Allow full deduction of the Guaranteed Income Supplement and other social assistance payments.
• Fully exempt capital gains on eligible sale to Employee Ownership Trusts.

In the most recent draft legislation, the following key amendments, which were not included in the NWMM, were included:

• Fully exempt capital gains on eligible sale to Employee Ownership Trusts.
• Inclusion rate for capital gains that are subject to the lifetime capital gains exemption and income from donated stock options at 30 per cent.

Foreign affiliates and hybrid surplus

The draft legislation introduces a bifurcation to the existing “hybrid surplus” pool into two distinct surplus pools: 

Legacy hybrid surplus:

• Includes capital gains/losses from dispositions occurring before June 25, 2024.
• Includes dividends paid before June 25, 2024, and dividends paid out of the legacy hybrid surplus of a foreign affiliate.

Successor hybrid surplus:

• Includes capital gains/losses from dispositions occurring after June 24, 2024.
• Includes dividends paid out of the successor hybrid surplus of a foreign affiliate.
• Taxpayers are required to separately track taxes applicable to the legacy and successor hybrid surplus of their foreign affiliates.

The tax treatment of these dividends is as follows:

For dividends paid out of legacy hybrid surplus, these dividends reflecting capital gains subject to the 50 per cent inclusion rate receive the same treatment currently available for hybrid surplus dividends. One-half of such dividends are deductible, along with a deduction for the hybrid underlying taxes applicable to these dividends.

For dividends paid out of successor hybrid surplus, these dividends, reflecting capital gains subject to the 66 per cent inclusion rate, are treated differently. Only one-third of such dividends are deductible, along with a deduction for the hybrid underlying taxes applicable to these dividends.

Contact your Baker Tilly advisor to learn more about how we can help you navigate the complexities of the Canadian tax system.