Rarely has there been so much talk about the relatively obscure capital gains tax provision. By announcing the increase in its inclusion rate last week, the Canadian Minister of Finance, Chrystia Freeland, raised all kinds of questions, notably as to the effect of the decision on middle-class households, on the motivation entrepreneurial and on the investment of companies in their productivity.
What is it about again?
Capital gains tax applies to the profit made when an individual or business sells an asset, such as shares or real estate. Unlike employment income, for example, only a fraction of these earnings is included in the calculation of the tax payable. For several years, one dollar in two (50%) of earnings has been included in the calculation of taxable income. As of June 25, this inclusion rate will increase to two dollars out of three (66.7%) on capital gains exceeding $250,000 in a year.
This general rule will be accompanied by all kinds of old and new exceptions. In particular, the capital gain from the sale of a principal residence will continue to be completely exempt. Small business owners will also retain an individual exemption which has been increased to 1.25 million and which will then be indexed. They will also be entitled to a new special inclusion rate of only 33% on an additional sum which could reach 2 million in 10 years.
Who gets the bill?
These changes should bring the federal government nearly 20 billion in additional tax revenue over five years, Ottawa estimates, at the rate of 8.8 billion from individuals and 10.6 billion from corporations. In Quebec, where the Minister of Finance, Eric Girard, quickly announced that he would harmonize his rules in this area with those of Ottawa, the expected additional revenue should amount to a total of 3 billion, including 1 billion from this year, reducing the projected budget deficit accordingly, from 11 to 10 billion.
As for individuals, this new bill will mainly go to the richest households, says Ottawa, which estimates that only 40,000 Canadians, or 0.13% of the population, will declare capital gains above $250,000 in 2025 while their total gross revenues will exceed 1.4 million on average. As for businesses, less than 307,000 out of almost 2.5 million, or 13%, declared capital gains in 2022. The latter then posted average taxable income ($702,000) four times higher than that of the others (174 000 $).
What about triplex owners?
Following Minister Freeland’s announcement, some were concerned about the impact that the new capital gains tax rules could still have on ordinary Canadians. As they do not affect assets held in the form of RRSPs or TFSAs, we quickly turned to the side of building or business owners. In particular, we cited the example of a small property owner who would, one day, sell his triplex, the value of which would have followed the surge in the market.
“You should know that even this small owner, who would realize a large capital gain at once, may well not be affected,” explains Luc Godbout, professor and holder of the Chair in Taxation and Public Finance (CFFP) at the University of Sherbrooke. Let us in fact suppose a triplex bought for $300,000 and sold for 1 million, of which he occupies one of the units and rents the other two. As one third of the $700,000 in capital gains corresponds to his principal residence, it is excluded from the calculation. As for the rest ($466,700), if he purchased the building as a couple, he will be able to share it in two with his partner (at $233,350) and thus remain below the individual threshold of $250,000.
It is on the side of the richest (business people, professionals, etc.), who have the possibility of choosing to be paid in salary, in dividends or even in capital gains, that things could change. As the maximum marginal tax rate on ordinary income in Quebec is 53.3%, it was until now much more attractive to be paid in capital gains — with 50% of these gains taxed at the rate. maximum of 53.3% for an effective rate of 26.7% — or even in dividends (40%), calculated the CFFP. The new rules reduce the interest of this little tax optimization game a little, at least beyond $250,000 of capital gains, where the new maximum rate would now be 35.5%, very close to that dividends.
What about entrepreneurship? And productivity?
Others fear that these tax increases will discourage entrepreneurship or reduce the level of business investment at a time when people are desperate for ways to devote more effort to improving their productivity.
In the case of small businesses, Chrystia Freeland not only “kept the belt and suspenders to avoid affecting their owners, but she added a second pair of suspenders,” says Luc Godbout about the new reduced inclusion rate of 33% which will eventually apply up to 2 million capital gains AFTER the basic exemption of 1.25 million. Ultimately, that is to say in 10 years, small entrepreneurs who declare up to 6.25 million in capital gains will pay less taxes, estimates Ottawa.
As for the tax rate faced by businesses and their investments in Canada, it will remain lower than that which other G7 countries apply to their own companies, argued the Trudeau government. Once all federal and provincial taxes are taken into account, as well as tax credits and deductions, a new investment will see its marginal effective tax rate increase from 14.3% this year to 16.8% in 2028, compared to an average in the six other countries of 24.8% this year, and an American competitor which will increase its rate from 19.7% to 24.9% within two years.
A dollar is a dollar
Until 1972, capital gains were not taxed. Driven by the principle “that a dollar should remain a dollar” in the eyes of tax, but keen not to discourage risk-taking by entrepreneurs, to encourage the sale and purchase of assets, as well as take into account the simple effect of inflation on the value of a long-term asset, their tax inclusion rate was limited to 50% until 1988. Afterwards, this rate was raised to 66.7%, then to 75% in 1990, where it remained until 2000, then falling to its current level.
Chrystia Freeland’s decision to postpone it to 66.7% (under certain conditions) probably responds much more to a need to find new sources of revenue in order to reduce deficits than to a sudden desire for greater tax fairness, says Luc Godbout. But one does not prevent the other.