Last month the Federal Government released its budget. They announced changes to the Lifetime Capital Gains Exemption for business owners and entrepreneurs, changes to the alternative minimum tax to address some issues that penalized charities, and measures to address affordable housing. In financial circles though, the change that is receiving the most attention was the surprise change to the Capital Gains Inclusion rate. I have included an article that discusses the highlights of all the changes, but I wanted to dive in a little further on the change to how capital gains are treated.
To start at the beginning, a capital gain occurs when you sell something for greater value than you purchased it, and applies to anything outside of a registered plan. It could be a piece of art, a business, a cottage or rental property (not your primary residence), or a stock or bond.
On the personal side, the budget has specified that the increase only applies to capital gains triggered in a year above 250K. That excludes many people, except in the case of properties, businesses or liquidation events (like an estate).
Corporations however do not get that 250K buffer.
Saving money in a corporate structure is a key strategy for business owners and professionals (such as doctors), so this has a direct impact on them. Let's look a little deeper on that.
Consider a stock purchased last year for $20, and is now worth $30. If you sell that today it would incur a $10 capital gain ($30-$20). Currently the inclusion rate is 50%, so as it stands, $5 gets added to income tax. If we assume a 50% corporate tax, that means a tax bill of $2.50 on that $10 gain. On June 25th, the inclusion rate goes from 50% to 66.67%. Applying the same math means the tax bill will be $3.34: 84 cents more.
That may not seem like much, but for doctors and business owners with Professional corp's and holding companies, those corporate holdings usually represent their largest savings. It's their nest egg. If they are currently sitting on a 1M unrealised gain, the difference is approx. 85K.
The Government has given us a window until June 25th to make adjustments. Many people selling businesses or buying/selling cottages have moved the closing dates up, but in the case of the investment portfolio a decision needs to be made on whether it makes sense to trigger the gains in the portfolio.
Looking at the above example, it seems to be an automatic "yes", but there's another side to consider: the time value of money. By triggering the gain today, you are saving tax, but you are paying a tax bill before you otherwise would. In the above example with a 1M unrealised gain, you are saving an eventual 85K in tax, but you are paying 250K today instead of later 334K later, and that 250K would otherwise be available to grow in the portfolio and increase your wealth.
The decision of whether or not to trigger it depends on two factors: the length of time before you otherwise would have triggered it, and your rate of return.
I will stress that if you are concerned about this, it needs to be discussed with an accountant. The time value of money cannot be understated. There is also the consideration that this gets amended or reversed at a future date. No one knows that answer, but it adds to the uncertainty.
Generally speaking, the advice our clients are receiving tend to be to consider triggering it if there is a need for the funds in the short term. If the liquidation date is unknown, or medium to long term, then the advice is mixed.
I've attached a summary of the budget changes, as well as a more in depth article regarding the considerations of someone with savings in a corporation.
Planning Considerations for Corporations