Taxpayers and advisors have been anxiously awaiting an update since April 16, when the Federal Budget dropped arguably the most significant (and controversial) change to tax policy in over 20 years.
The Notice of Ways and Means Motion (“NWMM”) was tabled June 10, 2024, and it is a stand‑alone motion to introduce the changes to the inclusion rate of capital gains in taxable income. It has been communicated by the government that this bill will be voted on ahead of the summer break, while the remainder of the unreleased budget material will wait until the fall.
In the 2024 Budget documents, two major changes were initially proposed:
- For individuals, the capital gains inclusion rate to be increased from 1/2 to 2/3 with a $250,000 safe harbour before the rate increased to 2/3.
- For corporations and trusts, the capital gains inclusion rate to be increased from 1/2 to 2/3 with no safe harbour.
The NWMM expanded on these proposals, addressing graduated rate estates and qualified disability trusts by granting them eligibility for the $250,0000 safe harbour on gains not allocated to beneficiaries in the year. To our knowledge, this was the only recommendation implemented by the Department of Finance. There is an overarching theme in the legislation bifurcating the year into Period 1 (Jan. 1 – June 24) and Period 2 (June 25 – Dec. 31), which are detailed below.
The NWMM includes the following new legislation:
$250,000 safe habour for individuals
The first $250,000 of capital gains realized by an individual (as noted, excluding trusts not identified above) will continue to be taxable at the 1/2 inclusion rate. This safe harbour comes into effect on June 25, 2024, and as detailed in the budget documents, this will apply after capital losses, the lifetime capital gains exemption, the employee ownership trust tax exemption and the Canadian entrepreneurs’ incentive rate reduction.
The safe harbour is applied by calculating a deduction equal to up to ⅙th of the $250,000 amount using a formula termed the capital gains reduction.
Here’s a simple example using a $100,000 capital gain:
$100,000 × 2/3 = $66,667
$100,000 × 1/6 = $16,667
$66,667 − $16,667 = $50,000 income inclusion
Partnerships and trusts
Partnerships generally allocate income at the end of the period pursuant to the governing partnership agreement. In many cases, these partnerships will have a fiscal period that straddle June 25, 2024. Those taxable capital gains, losses or allowable business losses will be grossed up back to the original amount and deemed to be realized by the relevant partner on the relevant date. Partnerships will be required to disclose to partners which gains arose during which period to assist in defining whether the gains are attributable to Period 1 or Period 2.
Trusts (family trusts and others) will similarly gross‑up their taxable capital gains, losses or allowable business losses back to their original amount and be deemed to be recognized by the relevant beneficiary. Trusts will disclose to those beneficiaries which gains arose during which period.
Transitional rules
The mechanics of these transitional rules are quite involved. The individual is required to net capital gains against capital losses in each period to determine a cumulative capital gain or loss, and the following capital gain inclusion rate is applied.
Here is an illustration of the applicable rates:
Capital gains reserves
Capital gains reserves will be included in the income of a taxpayer on the first day of the taxation year. For a taxpayer with a Dec. 31, 2024 year‑end, the reserve will be included on Jan. 1, 2024 and will be subject to the Period 1 inclusion rates. However, if the taxpayer has a June 30, 2025 year‑end, the reserve will be included on July 1, 2024 and will be subject to Period 2 inclusion rates.
Net capital loss carryforward balances
Net capital losses will be adjusted to reflect the applicable inclusion rate. If a net capital loss was realized when the inclusion rate was ½ and utilized after the increase to the capital gains inclusion rate, it will be multiplied upwards to 4/3, allowing the capital loss to offset an equivalent capital gain. This eliminates the mismatch between periods.
Employee stock option deduction
In line with the proposed amendment to the inclusion rate, the stock option deduction will be decreased to 1/3 of the stock option benefit for stock options exercised (or in the case of a CCPC, disposed of) on or after June 25, 2024. The annual $250,000 safe harbour would apply to the stock option benefit and any capital gains for a particular taxation year.
Business investment losses
In line with the increase in the capital gains inclusion rate, after June 24, 2024, 2/3 of business investment losses (“BIL”) will be deductible. Unlike other capital losses carried over, BILs will not be adjusted to reflect the inclusion rate that applies in the year the loss is claimed. As it stands, it appears that if the BIL is carried back, it will be more valuable than a pre‑June 25, 2024 BIL.
International tax
To mirror the implementation of the increased inclusion rate, the following international tax measures were proposed.
Withholding tax rate for non‑residents disposing of taxable Canadian property will be increased from 25% to 35% effective on dispositions occurring on or after Jan. 1, 2025.
Changes will be made to the calculation of foreign accrual property income of a foreign affiliate and deductions for dividends received from foreign affiliates’ hybrid surplus pool.
Additional commentary from Finance
In their news release, Finance outlined several items which will not be changed:
- The principal residence exemption
- Elections to realize unrealized capital gains
- Capital gains averaging over multiple years to benefit from the $250,000 threshold
- Splitting the $250,000 threshold with corporations
- Exemptions for specific assets or corporations
- Time‑based rules for capital gains
Next steps
Contact your Baker Tilly advisor to learn more about how we can help you navigate the complexities of the Canadian tax system.
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