Introduction – The Department of Finance Announces Revised Draft Legislation for Anticipated Capital Gains Changes
On August 12, 2024, the Department of Finance released revised draft legislation for the implementation of various federal tax measures, including the implementation of the 2024 Federal Budget. The Department of Finance has segregated these changes into five major categories:
- Legislative measures to implement Budget 2024 provisions;
- General technical amendments to the Income Tax Act and Income Tax Regulations (including amendments to controversial trust reporting rules);
- Amendments to the Global Minimum Tax Act and Income Tax Conventions Interpretation Act (to maintain the currency of legislation with recent OECD guidance, and the implementation of the undertaxed profits rule flowing from Pillar 2 of the OECD global minimum tax regime);
- Amendments to the Excise Tax Act and other indirect tax legislation; and
- Amendments to implement an increase in the capital gains inclusion rate and lifetime capital gains exemption for Canadian taxpayers.
The Department of Finance has opened a solicitation period for comments; it will be soliciting comments concerning the proposed Capital Gains Package, until September 3, 2024, and will accept comments concerning the other proposed amendments until September 11, 2024.
This article aims to narrowly survey the Department of Finance's Capital Gains Package, and further proposed amendments to the capital gains rules originally announced on April 16, 2024. This article will begin by briefly surveying the original scope of capital gains changes announced on April 16th. This article will then survey the most significant changes proposed by the Department of Finance to those draft rules on August 12, including (i) updates to the Alternative Minimum Tax rules, (ii) amendments to the capital dividend account rules for corporations, and (iii) updates to the hybrid surplus rules.
A Brief Summary of Budget 2024 Proposed Capital Gains Changes
On April 16, 2024, the newly-released Federal Government's 2024 Budget proposed a substantial change to the structure of taxing capital gains in Canada. Under those proposals, on and after June 25, 2024, the capital gains inclusion rate for Canadian taxpayers would be increased as follows:
- An individual's capital gains inclusion rate would be one-half by default, and would increase to two-thirds on the portion of capital gains realized in excess of $250,000 in that tax year; and
- Corporations and trusts, by default, would be subject to a capital gains inclusion rate of two-thirds on all capital gains.
In addition, the proposed amendments included an increase to the Lifetime Capital Gains Exemption ("LCGE") from $1,16,836 to $1,250,000, providing a small window of relief for small business owners cashing out on shares of their businesses or after June 25, 2024.
Summarizing the August 16th Amendments to Proposed Capital Gains Legislation
The Department of Finance's updated legislative proposals, released on August 12, 2024, are substantively the same as the original draft legislation released on June 10, 2024. But following outpouring of comments and criticisms from experienced tax lawyers and other tax practitioners, a number of highly nuanced amendments have been introduced that should be noted by Canadian tax experts and generally by high-net-worth individual taxpayers.
Alternative Minimum Tax Amendments
The Alternative Minimum Tax ("AMT") regime, found under section 127.52 of the Income Tax Act, subjects high-income earners to a minimum basic tax where their tax obligations would fall below a specific, undesirable, threshold. Bill C-69, Budget Implementation Act, 2024, No. 1, which received Royal Assent on June 20, 2024, updated the AMT rules for tax years beginning after December 31, 2023.
The Department of Finance's August 12th draft legislation includes a number of amendments to the AMT regime for individuals and trusts, to ensure the calculation of AMT maintains continuity with the capital gains inclusion rate changes to take effect as of June 25, 2024. These bridging provisions were absent from the original Notice of Ways and Means Motion introduced by the Department of Finance on June 10th.
Further, the amendments propose to preserve the tax-free nature of capital gains on the sale of a business to an employee ownership trust or a worker cooperative for AMT purposes as well, and to harmonize the new AMT rules with the employee ownership trust rules implemented on June 20, 2024.
Reconciling Corporate Capital Dividend Accounts for Straddle Years
Prior to the August 12th proposed amendments, and under the draft legislation tabled June 10, 2024, Canadian-controlled private corporations ("CCPC") could be subject to inequitable tax treatment when realizing capital gains, depending on the year-end of the corporation.
Simply put, the capital dividend account of a Canadian-controlled private corporation tracks the non-taxable component of capital gains realized by a corporation. The accumulation of a corporation's capital dividend account balance allows that corporation to declare "capital dividends" to shareholders, which are received tax-free. In essence, the capital dividend account helps preserve the tax treatment of capital gains realized by corporations and natural persons, as a component of achieving integration.
Under the June 10th provisions, a CCPC with a tax year ending after June 24, 2024, and including June 25, 2024 (e.g. a corporation with a calendar year-end) would be required to apply a blended pre- and post-amendment inclusion rate for calculating the capital dividend account in connection with dispositions throughout the entire taxation year. Under the August 12th proposed amendments, the capital dividend account is calculated with separate consideration to gains incurred before June 25, 2024 (subject to a one-half inclusion rate) and on or after June 25, 2024 (subject to a two-thirds inclusion rate), eliminating the blended inclusion rate previously employed.
Hybrid Surplus Rule Updates
Section 113 of the Income Tax Act includes a statutory regime to exempt dividends paid to a Canadian corporation by a foreign affiliate out of certain kinds of income earned in a treaty country from Canadian taxation. Broadly speaking, a one-half deduction is permitted on dividends when paid out of a foreign affiliate's "hybrid surplus", which includes specific kinds of capital gains.
The Department of Finance's August 12th proposed amendments introduces a two-tier system of hybrid surplus pools to ensure the capital gains realized by a foreign affiliate are taxed in accordance with the capital gains inclusion rate changes to take effect as of June 25, 2024. Capital gains realized before June 25, 2024, by a foreign affiliate and paid to a Canadian-resident corporation would remain eligible for the one-half inclusion rate (the "legacy hybrid surplus") while capital gains realized on or after June 25, 2024, would be subject to the two-thirds inclusion rate (the "successor hybrid surplus"). By default, a dividend is deemed to be paid out first from the legacy hybrid surplus pool, and then the successor hybrid surplus pool.
Pro Tax Tip: The Budget Implementation Process is Always in Motion, so Plan Accordingly
In the famous words of Mark Twain: "Those that respect the law and love sausage should watch neither being made." And twofold so for income tax legislation.
A Government Bill like a federal budget can be expected to receive Royal Assent at some point in the future. And further amendments to the August 12th legislation released by the Department of Finance are almost certain. It is a complete unknown what the final implementing legislation will look like until the Parliamentary reading process is complete.
But for expert Canadian tax lawyers and other tax consultants, this process of drafting, revising, public consultations, and readings shapes expectations about the final legislation that will become law, and if anything needs to be planned for in advance. And even though the changes to capital gains inclusion rates are intended to take retroactive effect as of June 25, 2024, as these August 12th amendments show, that is far from the only consideration. Any high-net-worth individual or corporation potentially affected by these changes should be in active consultation with an expert Canadian tax practitioner to ensure these amendments are noted, and that any steps needed to comply with this rapidly-changing legislation can be taken in time. If you or your business are in any way impacted by these changes and are uncertain about how these August 12th amendments may impact your affairs, you should engage an expert Canadian tax lawyer to review the matter thoroughly for you, and on a recurring basis for future amendments.
FAQs:
What is a Capital Gain?
Broadly speaking, a capital property is a property which you purchase for investment purposes or to earn income (as opposed to inventory traded as part of a business). A capital gain or loss occurs when a taxpayer sells a capital property. Under Department of Finance's draft legislation to implement the 2024 Federal Budget, the inclusion rate for capital gains in a taxpayer's income would be as follows:
- An individual's capital gains inclusion rate would be one-half by default, and would increase to two-thirds on the portion of capital gains realized in excess of $250,000 in that tax year; and
- Corporations and trusts, by default, would be subject to a capital gains inclusion rate of two-thirds on all capital gains.
What is the Status of the Tax Rules Proposed in the 2024 Federal Budget?
The Department of Finance first released draft legislation to implement changes to the Income Tax Act featured in the 2024 Federal Budget on June 10, 2024. The Department of Finance has released revised legislation on August 12, 2024, and has opened a solicitation period for comments from the public. It will be soliciting comments concerning the proposed capital gains inclusion rate changes until September 3, 2024, and will accept comments concerning the other proposed amendments until September 11, 2024.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.