The 2024 federal budget proposed a significant shift in the taxation of capital gains which will have implications for some taxpayers, including incorporated business owners that realize capital gains within their corporation. Effective June 25, 2024, the capital gains inclusion rate will increase from 50% to 66.67% for corporations and trusts, and for individuals on the portion of capital gains exceeding $250,000 in a given calendar year. This article is intended to identify the potential impact to your corporation. 

Please note: Legislation has not been released at this time.

Corporations will be subject to the higher 66.67% inclusion rate on all capital gains. The capital gains tax rate for corporations in Alberta is currently 23.33%. As a result of these changes, corporations will pay 31.11% on any capital gains realized after June 25. However, some of this corporate tax is refundable to the corporation when a dividend is paid to the shareholder. 

Currently, when a capital gain is earned inside a corporation and then distributed to a shareholder, the maximum combined corporate and personal tax paid is 25.77%. When compared to the current maximum personal tax rate on capital gains of 24%, there is only a 1.77% benefit in earning capital gains personally as opposed to inside of a corporation. 

As a result of the proposed changes, the maximum combined rate for earning a corporate capital gain will increase to 34.36%. Capital gains below $250,000 earned personally in a given year will now be taxed at a significantly lower rate than those in a corporation.

For example, if a corporation realizes a capital gain of $200,000 and distributes the after-tax income to the shareholder, the shareholder would receive $131,280 after tax (assuming the dividend will be taxed at the top marginal rate in Alberta). If that same individual realized a capital gain of $200,000 personally they would have after-tax income of $152,000. As a result, it is now 10.36% more expensive for corporations to earn capital gains below $250,000 than it is for an individual to earn that same amount.

Due to this immediate impact, corporations may have more of a need to consider action before the June 25 deadline at lower dollar thresholds. Determining whether it is beneficial for corporations to realize capital gains in advance of this date will require shareholders to carefully consider their long term plans for any corporate investments as well as their personal cash flow needs from the corporation. 

If you are planning on selling an asset in the short term it may be evident that you should realize the gain prior to June 25. If you are not planning on selling in the near term, the decision is less straightforward.

Though triggering a capital gain today means a lower corporate tax bill, it also means you have to pay that tax bill sooner. Deferring the tax bill—despite the expectation of a higher future inclusion rate on capital gains—can still be advantageous in some situations due to the opportunity cost of paying that tax bill now instead of later. The opportunity cost depends on your expected returns, which is determined based on how the assets you would otherwise use to pay the tax bill are invested. Corporate investors should meet with their financial advisor and tax advisor to determine whether crystallizing any gains might be beneficial. 

Below we walk through two scenarios corporate investors might face.

In determining whether a corporation should crystalize unrealized gains, shareholders will need to consider when they would otherwise be selling the assets in the corporation. They also need to determine if they plan on withdrawing the surplus from the corporation once the gain is realized.

If a corporation is simply considering whether to dispose of a corporate investment to purchase another corporate investment, the decision may be more straightforward. In these circumstances, the breakeven point is similar to that for personal gains. For example, if an incorporated business was planning to sell investments in order to purchase a building and this was going to be purchased within the next few years, they may benefit from crystallizing the gains on those investments prior to June 25.

As a general guideline, the longer the time horizon for the investment, the less benefit there will be to realizing a gain now. A higher expected rate of return on your investment would have a similar impact.

The situation becomes more complex if you also need to analyze withdrawal of the after-tax corporate proceeds.

For example, if you have a corporate investment portfolio that you are currently using to fund your retirement, you will need to consider how much of those corporate investments you will need to liquidate over the coming years to fund your cash flow requirements. Both the corporate tax on the liquidation of the portfolio as well as the personal tax on the distribution of the funds will need to be considered.

If instead you have enough personal funds to meet your retirement cash flow needs and you are planning on passing your corporate portfolio to your children as an inheritance as part of your long-term plan, you may benefit from continuing to defer the tax. However, individuals planning to leave shares of an investment holding company as part of their estate should still discuss their overall estate planning goals with their financial advisor, along with their legal and tax advisors as there may be other planning opportunities to explore.

Let’s review an example:

Noah has a corporate investment portfolio with an adjusted cost base (ACB) of $500,000 and a fair market value (FMV) of $1,000,000. He has been prudent with his financial planning and has brought his tax and financial advisors together to discuss his future plans. He indicates that in five years he plans to travel the world and will also be purchasing a vacation property during his travels. As such, he planned to liquidate his corporate investment portfolio in five years time. He wonders whether he should realize the accrued gains now instead?

A breakeven analysis considered in isolation may suggest that unless Noah’s expected rate of return is quite high, he may wish to consider realizing the corporate capital gains now at the lower inclusion rate.

Noah’s advisors raise several additional factors for Noah to consider, however, before making a decision:

• The certainty of timing: Might he decide to accelerate or defer his travel and property purchase plans? Is the five-year timeline definite?
• The certainty of expense: How certain is Noah regarding the cost of his planned expenses? The location of his planned vacation property appears to be undetermined. Could location impact the cost of his purchase? Is there a possibility that he may proceed with his travel plans but not buy a vacation property or vice versa? If Noah’s cash requirements are uncertain, it may not make sense to realize the entire capital gain.
• The certainty of legislation: Is there a possibility that changes are made to the proposals when legislation is released? There may be a measure of risk in acting prior to legislative changes being made. Should planning be considered where the decision of whether to realize the gain can be deferred?

While a breakeven analysis can be a useful tool to consider, it is important to recognize that the components of the calculation may be subject to change.

Fatima is the sole shareholder of an incorporated business, with the active operations having been recently wound down. She sold all the assets of her business and all that remains in the corporation is $500,000 in cash. She was planning to invest the $500,000 in her corporation and draw dividends when needed. Based on her planned monthly expenses, Fatima’s financial advisor informed her that her personal assets are expected to cover all of her retirement cash flow needs. 

Fatima heard about the increase to the capital gains inclusion rate and asked her accountant whether she should withdraw the $500,000 from the corporation today and invest it in her personal name since corporate capital gains below $250,000 are going to be taxed less favorably than personal capital gains. 

Fatima’s company does not have any shareholder loans or a capital dividend account balance which would allow her to withdraw the money from the corporation tax free. Therefore, if Fatima were to withdraw $500,000 from her corporation today, she would need to pay personal tax on the dividends paid from the corporation up to a maximum rate of 42.31%, depending on her tax bracket. Assuming she was already in the top tax bracket in Alberta, this would leave her with $288,450 to invest personally. 

Alternatively, Fatima could leave the $500,000 to grow in the corporation. Let’s assess the after-tax value of each situation. (Assumptions: expected rate of return of 5%¹; personal tax is paid at the top marginal rate in Alberta; no other personal capital gains are realized).

The table above illustrates the benefit of leaving the funds in the corporation. Though Fatima will be paying more on corporate gains in the future, there is still a benefit to deferring the tax on the initial investment capital.