Individuals, corporations, and trusts should take a close look at the recent updates concerning capital gains taxation as outlined in the 2024 federal budget. The Finance Department has unveiled draft legislation aimed at introducing the Canadian Entrepreneurs’ Incentive, which allows individuals to apply a reduced 1/3 inclusion rate on specific capital gains from eligible dispositions, beginning in 2025. This draft legislation incorporates several revisions to the original budget proposal, including broader eligibility criteria and a quicker five-year implementation timeline.
Moreover, Finance has issued updated draft legislation to clarify changes to the capital gains inclusion rate for gains realized on or after June 25, 2024. While much of this draft remains consistent with the version released on June 10, 2024, taxpayers will find several important updates, including new transitional rules impacting the capital dividend account (CDA) and hybrid surplus.
Finance is open to receiving feedback on these draft proposals until September 3, 2024, for the capital gains legislation and until September 11, 2024, for the Canadian Entrepreneurs’ Incentive.
The 2024 federal budget introduced an increase in the capital gains inclusion rate from 1/2 to 2/3 for corporations, trusts, and individuals on the portion of capital gains exceeding $250,000 within a calendar year. This new inclusion rate is set to apply to any dispositions occurring on or after June 25, 2024. It’s important to note that the $250,000 threshold for individuals will only apply to net capital gains realized after June 25, 2024, without prorating for that year.
Alongside these changes, the budget also proposed several related amendments, such as reducing the employee stock option deduction from 1/2 to 1/3, and introducing transitional rules for tax years that span June 25, 2024, where two different inclusion rates may apply.
To alleviate some of the impact of the increased inclusion rate, the budget introduced the Canadian Entrepreneurs’ Incentive. This incentive permits individual taxpayers to apply a 1/3 inclusion rate on capital gains from the sale of qualifying shares, subject to a lifetime limit of $2 million in capital gains. This limit is in addition to any available Lifetime Capital Gains Exemption (LCGE) and will be phased in by $200,000 increments each year until 2034. The incentive applies to dispositions occurring on or after January 1, 2025. However, some of these details have been updated in the recently released draft legislation.
The budget also raised the LCGE to $1.25 million (up from $1,016,836) for dispositions occurring on or after June 25, 2024.
Draft legislation for these proposed capital gains changes (excluding the Canadian Entrepreneurs’ Incentive) was first released on June 10, 2024. At that time, Finance acknowledged the need for further amendments and committed to providing updated draft legislation along with details on the Canadian Entrepreneurs’ Incentive by the end of July 2024.
Canadian Entrepreneurs’ Incentive
The new draft legislation elaborates on the Canadian Entrepreneurs’ Incentive, including several changes to the eligibility requirements initially proposed in the 2024 federal budget. These adjustments are aimed at expanding access to the incentive, which effectively allows eligible individuals to apply a 1/3 inclusion rate on capital gains from the sale of qualifying shares, subject to a phased-in lifetime limit of $2 million.
Key changes include:
- Expanding eligibility to include business owners beyond just founders
- Lowering the minimum ownership requirement from 10% to 5%
- Reducing the required ownership period to any continuous 24-month period before the sale (down from a minimum of five years ending just before the sale)
- Shortening the required period of active involvement in the business to any combined three-year period since the business’s inception (down from five years)
- Extending the incentive to dispositions of qualified farming and fishing property
Additionally, the draft legislation speeds up the annual phase-in of the $2 million lifetime cap, increasing it to $400,000 per year (up from $200,000), with the full cap being reached by 2029 instead of 2034.
The draft also details certain business types that are excluded from the incentive, including professional practices and businesses in sectors such as finance, insurance, real estate, food and accommodation, arts, recreation, and consulting services, among others.
Other Updates Related to the Capital Gains Inclusion Rate Increase
The updated draft legislation largely aligns with the version released on June 10, 2024, but includes clarifications on calculating the CDA and hybrid surplus, along with other relevant changes.
Capital Dividend Account
The draft legislation introduces adjustments to address issues with calculating a corporation’s CDA balance during a transition year—specifically, for tax years beginning before June 25, 2024, and ending on or after that date. The revised rules adjust the CDA by 1/2 of the capital gain (or loss) for dispositions before June 25, 2024, and by 1/3 for those occurring on or after that date. A “true-up” mechanism at the end of the transition year ensures the CDA balance is correctly adjusted based on the blended inclusion rate.
The revised rules also clarify how net capital losses are applied against taxable capital gains from different years with varying inclusion rates, allowing a capital loss to fully offset an equivalent amount of capital gain regardless of differing inclusion rates.
Foreign Affiliates and Hybrid Surplus
The draft legislation also amends the foreign affiliate hybrid surplus regime to reflect the increased capital gains inclusion rate for gains realized on or after June 25, 2024. Dividends from a foreign affiliate’s hybrid surplus will be subject to the new inclusion rate if the surplus arose from gains realized after that date.
Two new hybrid surplus pools are introduced: legacy hybrid surplus (for gains realized before June 25, 2024) and successor hybrid surplus (for gains realized on or after that date). Dividends received after June 25, 2024, will first be drawn from the legacy hybrid surplus, which remains eligible for the 1/2 inclusion rate, before being taken from the successor hybrid surplus, subject to the 2/3 inclusion rate.
Additional Amendments
As anticipated, the draft legislation also includes changes to the alternative minimum tax (AMT) for individuals and trusts to reflect the increased capital gains inclusion rate, applicable to taxation years ending after 2023.
To prevent multiple deductions of the same amount under various capital gains exemptions and incentives, the revised legislation introduces an ordering rule. This rule stipulates that the LCGE must be claimed only after applying any capital gains exemption under the Employee Ownership Trust (EOT) rules, and before utilizing any available amount under the Canadian Entrepreneurs’ Incentive.
Need Expert Guidance?
Navigating the complexities of these changes and understanding their implications on your financial situation can be challenging. The team at ClearWealth Accounting Advisors is here to help. Whether you’re an individual, corporation, or trust, our experts can provide tailored advice to ensure you’re fully prepared for these new regulations. Contact ClearWealth today to schedule a consultation and secure your financial future.
