Capital Gains Inclusion Rate

There have been plenty of rumours surrounding what tax changes may be included in the upcoming 2020 Federal Budget. The date of the Budget has not been set by the government, but is expected to be released sometime in late March or early April. One of the more significant and controversial rumours that has been circulating is a change to the capital gains inclusion rate.

When someone disposes a capital property, the difference between the proceeds of disposition (fair market value or FMV) and the adjusted cost base (ACB) is a capital gain. Capital gains are currently taxed at a 50% inclusion rate. However, this was not always the case. Before 2000 the inclusion rate was 75% and in 2000 it was first reduced to 66.6% and then later it was cut to 50% and has been maintained there since.

Rumours about a change in the inclusion rate have circulated for the past couple of years.  However, in the last year, some of the political winds have shifted. The current federal Government is in a minority position. In the past couple of years, the Liberals have made a number of tax changes to close what they consider to be “loopholes” and to take away benefits that are viewed to benefit the so called “wealthy”. Though they didn’t make any specific commitments in their 2019 election platform, they did state that they would continue to tighten up tax breaks for the wealthy. The NDP actively campaigned in the 2019 election to increase the capital gains inclusion rate to 75%. The increase in revenues to the federal government by this change was estimated to be $8 billion per year. Given that the Liberals require another party’s support to pass the budget (and the NDP is probably the most closely aligned to them) and will need tax increases to fund more social programs (i.e. Pharmacare) and other spending initiates, many people are expecting this to happen. Any change in the inclusion rate would be effective immediately. Please note: We cannot be certain of any unannounced tax changes, so please read the following with caution.

Let’s consider an example. Mr. A. has real estate that he purchased for $500,000. The real estate is now worth $1.5 million and therefore he has an unrealized gain of $1 million. Under the current rules, he would have a taxable capital gain of $500,000 and estimated personal taxes (assuming highest marginal rate for 2020) of $268,000 if he disposed of the property at its fair value. If the inclusion rate were increased to 75%, the estimated personal taxes would increase to approximately $400,000 – a $132,000 increase.

Does it make sense to do some pre-planning? It really depends on the circumstances of the party in question. Here are some of the circumstances where one should consider some tax pre-planning:

  1. If you are planning to sell some capital property in the next couple of years and realizing the gain anyways, then it may make sense to trigger the gain earlier to “lock in” at the 50% inclusion rate versus risking an increase in your taxes. Further, one may be able to structure the transaction so that they transfer the property but have the ability to elect at an amount lower than FMV if there is no change to the inclusion rate in the budget.
  2. If your Company owns a property with a large accrued unrealized gain, and the shareholder is extracting a significant amount of funds from the company, it may be possible to realize the gain to create certain tax attributes to reduce the tax cost of the funds extracted.

We would not recommend someone trigger any accrued gain where they cannot realize the benefits within a relatively short period of time. Doing so for no other reason would just result in pre-paying taxes. Therefore, pre-planning is not for everyone.

If you are interested in discussing whether or not this may be beneficial for you or someone you know, please contact one of your Clearline advisors or Shane Schepens who leads our tax department.