The federal government’s decision to increase the capital gains tax rate to 66.7 per cent from 50 per cent has caused a lot of angst amongst business owners, professionals, investors and property owners, to name just a few.
But confusion still reigns about who these changes will affect and how. Neil Kumar, an adviser and portfolio manager at Richardson Wealth, answers three big questions about the increase.
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Who will be most affected?
“The federal government cites figures indicating that only a small percentage of taxpayers will be subject to the increased capital gains inclusion rate. In reality, a much wider spectrum of Canadians will be impacted by the changes, ranging from professionals and small-business owners/entrepreneurs to those who may own a second property.
“In general, any Canadian who has a trust or incorporated business (holding company) will see a significant increase in their taxes. Working professionals who are allowed to incorporate (for example, accountants, lawyers, doctors and realtors) and small-business owners will see the inclusion rate on capital gains rise by 33 per cent after June 25.
“In terms of numbers, according to the Government of Canada’s own stats, there were 1.19 million small-business owners as of December 2022 and these business owners employed roughly 46.8 per cent of the total private labour force. In addition to small-business owners, there are more than 210,000 accountants, 136,000 lawyers, 96,000 physicians and 160,000 realtors in Canada, many of whom have a holding company to invest their excess savings.
“In other words, the government’s figure of 0.13 per cent is grossly low. Individuals who invest through a holding company will also see a decrease in the amount going to their capital dividend account from 50 cents on each dollar of realized gains to 33 cents on each dollar of gains.
“Another group of Canadians who will be negatively impacted are real estate investors. While the sale of primary residences will remain excluded from capital gains tax, individual Canadians who own an investment property or recreational property will face a tax hit on the sale of a property as the capital gains inclusion rate will increase by 33 per cent for capital gains exceeding $250,000 (for professionals who own real estate in an incorporated business, the hit will be from the first dollar of capital gain).
“Once again, the government’s estimate about the number of impacted individuals is misleading. Approximately 4.4 million Canadians own an investment property, with one-third of them owning two or more properties, according to a Royal LePage survey in May 2023. Moreover, 11 per cent of Canadians own a cottage, with an equal number looking to buy one, according to a ReMax poll in 2023.”
How will it affect long-term investment strategies?
“Some initial thoughts, with the caveat that everyone should seek appropriate tax advice for their unique situation:
- Canada may be less attractive to invest in. We still need to digest how the increase in the capital gains inclusion rate will impact businesses. In general, higher taxes cause investments to be less profitable and might be viewed as a “disinvestment” incentive. This might cause capital to flow to jurisdictions with more favourable tax treatment, or simply cause global investors to avoid Canada.
- While the budget deficits are not getting bigger, we will need to see if increased government spending causes an increase in inflation.
- Some people with a shorter-term investment time horizon may choose to “crystallize” unrealized gains before the June 25 deadline.
- Less portfolio turnover (that is, trading activity).
- Life insurance may become a more attractive option to offset higher taxes upon death.”
How could it affect wealth and tax planning?
“We aren’t allowed to provide specific tax advice to our clients, but we actively work with their accountants to address tax issues. It seems like tax accountants are still formulating their own stance or opinion on the changes. So far, we have received varying opinions from the trusted accountants we know and work with, which seems reasonable given that each client is unique.
“These opinions range from advising their clients to crystallize as much capital gains as possible before the June deadline to doing nothing.
“The advice needs to be tailored to each client with an understanding of their current financial position, future goals and the likelihood of certain financial events happening.
“To illustrate this, let’s assume Client A is a 45-year-old entrepreneur who invests their surplus cash in their holding company. They have purchased shares in companies that have long-term growth potential and don’t anticipate selling their shares for the next 10 years.
“In this case, an accountant might advise them not to crystallize any current gains since the growth on the taxes saved today might be greater than the incremental tax hit in the future. In contrast, if the time horizon was only two years, the accountant might suggest crystallizing gains now.”
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