Death, emigration and retirement: Fed budget fallout

Article content

With capital gains in the spotlight in the recent federal budget, advisors who work with wealthy Canadians say the effects may follow them many years into the future.

The budget proposes an increase in the capital gains tax inclusion rate from one half to two-thirds for individuals with capital gains in excess of $250,000, effective June 25.

“The budget suggests that it will only impact about 0.13 per cent of Canadians so for sure the ultra-high-net-worth are targeted,” says Judith Charbonneau Kaplan, vice-president of advanced wealth planning at Wellington-Altus Private Wealth Inc. in Kelowna, B.C.

A broad spectrum of people, including incorporated professionals and business owners, as well as anyone with real property other than their principal residence, need to take note of this proposed change, adds Charbonneau Kaplan.

Businesses of all sizes are also targeted by this measure, including small business owners, who are “the backbone of the Canadian economy,” says Kris Rossignoli, a cross-border and tax financial planner with Cardinal Point Wealth Management ULC in Toronto.

While individuals only reach the higher two-thirds income inclusion threshold if they exceed $250,000 in capital gains, corporations and trusts need to apply the higher inclusion rate as of their first dollar of capital gains.

Business owners with wealth built inside their firms

“That means business owners who have built up significant investments in their holding or operating companies as part of their retirement plan are now facing a higher tax bill when accrued gains in their corporation and in their corporate investment portfolios get realized,” says Charbonneau Kaplan.

“So once they move into retirement and start to take those draws, those are automatically taxed at that higher rate, and that can have a pretty significant impact to business owners,” she adds.

How can ultra-high-net-worth Canadians protect themselves from footing a potentially much higher tax bill when it comes to capital gains?

One strategy could be to trigger capital gains on eligible investments in advance of June 25 so those capital gains only get subject to a 50 per cent inclusion rate, as opposed to the higher rate, suggests Charbonneau Kaplan.

For individuals contemplating that strategy, it is important to note that capital gains are being realized up front, which constitutes a prepayment of tax. If there are plans to sell the property in the short-term anyway, perhaps in a year or two, it might make sense to front load those capital gains, she says.

“[But] it might not make sense to front load capital gains if there’s a much longer time span on owning capital property,” adds Charbonneau Kaplan.

Capital gains strategy needs to consider alternative minimum tax

Another consideration for individuals is that the 2023 budget proposed a significant expansion of the alternative minimum tax, which has not yet come into law, but is expected to move forward and be effective backdated to January 1, 2024, says Charbonneau Kaplan.

“You could be triggering these capital gains to get the 50 per cent inclusion rate and accidentally fall into an AMT liability,” she warns.

Because of the increased inclusion rate on capital gains, if the investment income from an associated corporation group hits $50,000, their small business deduction would start to grind down by $5 for every $1 of investment income above $50,000, says Rossignoli.

With the small business deduction at $500,000, that means an extra $100,000 of aggregate investment income would fully grind down the small business deduction to zero.

Now, with the increase in the capital gains inclusion rate from 50 per cent to 66.67 per cent for corporations it is easier to hit that $50,000 amount, as an extra 16.67 per cent of realized capital gains will be included in investment income.

“So once you hit $150,000 of aggregate investment income in your associated corporate group, you no longer have any small business deduction for the year,” he elaborates.

“Anyone with a corporation or a trust needs to be talking to their advisors, or to get an advisor, as soon as possible before June 24, and assess their individual situation to see if it makes sense to continue with that corporation or trust, or if there is money they can get out of the corporation or trust into a more tax-efficient vehicle,” says Rossignoli.

Less money passing to younger generation

Death has also become more expensive for ultra-high-net-worth families, as families with assets with unrealized capital gains greater than $250,000 are now going to be subject to that higher two-thirds inclusion rate, due to the deemed disposition of all assets upon death, he notes.

As a result, “there is going to be less money passing down from that older generation to the younger generation,” warns Rossignoli.

‘I want to be out of Canada before June 25’

Rossignoli says his firm deals with many ultra-high-net-worth people departing Canada every year and there has been “a significant uptick in just the last few days of our clients and perspective clients already reaching out saying: ‘I’m an ultra-high-net-worth person in Canada,’ or ‘I’m a dual citizen. Help me get to the U.S. I want to be out of Canada before June 25.’”

To the extent that somebody already has a business in the U.S. with many connections south of the border, that might be a consideration, says Charbonneau Kaplan.

But she cautions that, in order to become a non-resident of Canada, individuals must sever ties with the country, which also means moving their family and their home. There is also a departure tax, with a deemed disposition of most assets, at which point accrued capital gains will be triggered.

“Most people aren’t really willing to do that,” she notes. “Ultimately, the decision to move out of country is a life decision. It’s not a tax decision.”

Michael Louie, principal at D&H Group, an accounting and tax advisory firm in Vancouver, says, “Most family businesses typically think generationally, so as a multi-family office my clients remain sanguine about the prospects for their business with these recently proposed capital gains inclusion rate tax changes.

“With respect to these tax changes, corporate income tax rates remain unchanged and are less than 27 per cent, which is competitive with other countries’ corporate tax rates.”

He adds that, “It is a 9-per-cent effective tax rate increase [in British Columbia] on the capital gains arising from their passing, so some will take tax planning action to mitigate these capital gains taxes; and worst case is that their testamentary gifts will be less.”

Lifetime capital gains exemption raised

Other proposed measures tabled in this budget will also impact wealthy and business-owner Canadians.

The lifetime capital gains exemption was raised from $1 million (indexed at $1,016,836 in 2024) to $1.25 million for gains realized upon the disposition of qualified small business corporation shares effective June 25, 2024.

As a result of the extra bump on the lifetime capital gains exemption, an additional nearly $235,000 [$1,250,000-$1,016,836], can be removed tax free. Assuming the top marginal tax rate of 53.53 per cent in Ontario, this calculates to approximately $150,000 in tax saved due to the increase in the inclusion rate of capital gains, explains Rossignoli.

“Saving $150,000 is nice, but that’s barely a downpayment on the average Canadian home in any Canadian major city,” says Rossignoli.

Entrepreneurs’ incentive

Effective January 1, 2025, the new Canadian Entrepreneurs’ Incentive may lower the amount of tax some small business owners will have to pay when selling shares of a company. Eligible entrepreneurs will only have a one-third inclusion rate on the capital gains from the sale, up to a lifetime limit of $2 million in capital gains, phased in over ten years.

“It is an interesting measure and definitely something to look into, but there are quite a few limitations put on it,” says Charbonneau Kaplan, who notes that this measure really only applies to shareholders who built their business from the ground up and own more than 10 per cent of the votes and value in the corporation.

There are also several excluded businesses, most notably professional corporations as well as entire industries, including financial, insurance, real estate, food and accommodation, arts, recreation and entertainment, she adds.

Please visit here to see information about our standards of journalistic excellence.