Will they or won’t they? Rumours continue to swirl that the Federal budget expected to come out in Feb/Mar 2017 may increase the capital gains inclusion rate from 50 percent to as high as 75 per cent.
Capital gains occur when you dispose of capital property, such as a stock, bond or mutual fund, for more than you paid for it and is only relevant if you hold such investments in a non-registered account (i.e. outside your RRSP, RRIF, TFSA or other tax-preferred account). Capital gains also occur when you sell real estate (other than your principal residence, in most cases) or private company shares for more than you paid for them.
Today only 50 per cent of capital gains are taxable. Accordingly, the effective tax rate on capital gains earned is half of your marginal tax rate on ordinary income, such as employment, business or interest income. For high-income earners, that means the effective marginal tax rate on capital gains earned by individuals in 2016 is approximately 25 per cent (approximately the same rate if earned in a corporation then paid to an individual).
The capital gains inclusion rate has been higher before: Capital gains were taxed at 75 per cent in 1990 before dropping to 67 per cent in 2000 and to 50 per cent in 2001.
Capital Gains increase example:
For example, if you (or one of your Canadian companies) sells a capital property that has a fair market value of $2M and an original cost of $500,000, you will earn a capital gain of $1.5M ($2M less $500k). The taxable portion today would be equal to 50% of the capital gain, or $750,000 ($1.5M x 50%). The tax cost of this capital gain would be approximately $375,000 ($750k x 50%).
If the Federal budget changes the 50% inclusion rate to 75% then the taxable portion of the capital gain would be $1,125,000 ($1.5M x 75%) instead of $750,000. The tax cost of this capital gain would be $562,500 ($1,125k x 50%) which is $187,500 more than the tax under the current rules!
Planning Opportunities Available
If you own capital property that has a significant accrued capital gain (current fair market value is greater than the original cost), there may be tax planning opportunities that can be implemented to lock in the existing 50% inclusion rate. If a current year sale is imminent, you may want to ensure the transaction closes prior to budget date. In any event, the time to act is now as such planning opportunities will need to be executed before any changes to the tax legislation are announced by the Federal Government.
Please contact your trusted DMCL advisor to learn how these potential changes could affect you and your family, and to learn how we can help you by identifying constructive planning opportunities.