Federal budget 2024―and you thought there would be nothing?!

Finance Minister Chrystia Freeland tabled the 2024 Federal Budget on April 16, 2024. After years of speculation, this was finally the budget in which the capital gains inclusion rate was increased. The budget included some relief to higher capital gains taxes through an increased lifetime capital gains exemption (LCGE), sales of business to employee ownership trusts (EOT), and the introduction of the Canadian Entrepreneurs’ Incentive (CEI). Additional measures around noncompliance with information requests, avoidance of tax debts, and penalties for reportable and notifiable transactions were also introduced. There are many other points of interest to insurance and investment advisors concerning first-time homebuyers and much more. 

Capital gains inclusion rate

Budget 2024 proposes to increase the capital gains inclusion rate from ½ to ⅔ for corporations and trusts for capital gains realized on or after June 25, 2024. For individuals, the inclusion rate will remain at ½ on the first $250,000 of capital gains realized and ⅔ on the portion of capital gains realized in the year that exceed $250,000 on or after June 25, 2024.

The $250,000 threshold would effectively apply to capital gains realized by an individual either directly or indirectly through a partnership or trust, net of any capital losses (current or applied from other years) and capital gains where the LCGE, the proposed EOT exemption, or the proposed CEI is claimed.

The rules will allow net capital losses realized prior to the rate change to fully offset an equivalent capital gain realized after the rate change.

In addition, for tax years that begin before and end on or after June 25, 2024, two different inclusion rates would apply―½ before June 25, 2024, and ⅔ on or after June 25, 2024. The annual $250,000 threshold for individuals will be fully available with no proration.

Capital gains related to the sale of real estate in which the principal residence exemption was used won’t be affected by these changes and will continue to be exempt from tax regardless of the dollar value of the capital gain.

Where an individual claims the employee stock option deduction, the budget provides a ⅓ deduction of the taxable benefit to reflect the new capital gains inclusion rate, but that individual would be entitled to a deduction of ½ the taxable benefit up to a combined limit of $250,000 for both employee stock options and capital gains.

These changes may have a material impact on a variety of different issues relating to tax and estate planning (subject to draft legislation being issued) as follows:

• Terminal tax obligations may be greater for taxpayers overall.
• The calculation of capital dividend account (CDA) amounts to corporations. Where the capital gains inclusion rate is ⅔ (meaning only ⅓ of the gain is nontaxable), only ⅓ of the gain will get credited to the CDA. 
• It may also affect postmortem planning to minimize double taxation on the death of a private corporation shareholder.
• Life interest trusts won’t be eligible for the $250,000 exemption. This can create greater terminal tax liabilities in these trusts relative to owning the assets directly.  
• It will reduce the tax rate gap between dividends and capital gains, which may lead to a reduction in the use of capital gains stripping transactions that involve generating personal income from a corporation at capital gains rates versus dividend rates.
• Capital losses will reduce capital gains at the same inclusion rate of the capital gain. Tax-loss selling to realize capital losses when capital gains are over $250,000 will fully offset such gains. Capital losses from other years may be more valuable when used to reduce capital gains included at the higher ⅔ rate.
• For corporations, capital gains will increase their Adjusted Aggregate Investment Income (AAII) more quickly. For example, a total capital gain of $74,627 will create $50,000 of AAII at a ⅔ inclusion rate; previously, a $100,000 total capital gain was needed. The small business deduction (SBD) is reduced by $5 for every $1 of AAII starting at $50,000. Conversely, current year capital losses, which reduce AAII, are more valuable at a ⅔ inclusion rate.
• It may create an incentive to trigger capital gains before June 25, 2024.
• It may result in revisiting the investment mix between personal and corporate portfolios to take advantage of the ½ capital gains inclusion rate on the first $250,000 for individuals.
• There may be more incentive to have corporations gift publicly traded securities and segregated fund contracts to charity thereby increasing the CDA credit and avoiding the ⅔ capital gains inclusion rate.
•  There may be more incentive to move corporate dollars into the tax-free environment of an exempt life insurance policy.

Finance has indicated additional details are coming.  

Lifetime capital gains exemption increases

The LCGE is a tax exemption for capital gains realized on the disposition of qualified small business corporation shares and qualified farm or fishing property. The LCGE is currently $1,016,836 in 2024, indexed to inflation. Budget 2024 proposes to increase the LCGE to apply up to $1.25 million of eligible capital gains. This measure would apply to dispositions that occur on or after June 25, 2024. Indexation of the LCGE would resume in 2026.

Canadian Entrepreneurs Incentive

Budget 2024 proposes to introduce the CEI to dispositions of shares that occur on or after January 1, 2025.

This is an incentive that would result in a reduced tax rate on capital gains on the disposition of qualifying shares by an eligible individual by reducing the capital gains inclusion rate to ½ of the prevailing inclusion rate, on up to $2 million in capital gains per individual over their lifetime. This measure would apply in addition to the LCGE.

The lifetime limit is scheduled to be phased in by increments of $200,000 per year, beginning on January 1, 2025, before ultimately reaching a value of $2 million by January 1, 2034.

Under the ⅔ capital gains inclusion rate proposed in Budget 2024, this measure would result in an inclusion rate of ⅓ for qualifying dispositions.

Parts of the tests to qualify are similar to those for the LCGE, including the small business corporation requirement at the time of sale (i.e., the 90% rule), the 24-month holding period requirement as a Canadian-Controlled Private Corporation (CCPC), and that more than 50% of the fair market value (FMV) of the assets of the corporation were used principally in an active business carried on primarily in Canada by the CCPC or by a related corporation.

In order to qualify, there are additional requirements, including that the claimant be a founding investor who held the share for a minimum of five years prior to disposition and held more than 10% of the FMV of the issued and outstanding capital stock of the corporation and at least 10% of the votes. The claimant must also be actively engaged on a regular, continuous, and substantial basis. 

Finally, there’s a restriction that the corporation can’t be a professional corporation or a corporation that carries on certain types of businesses, including operating in the financial, insurance, real estate, food and accommodation, arts, recreation, or entertainment sector or providing consulting or personal care services.

Employee Ownership Trusts

EOT’s were first introduced in Budget 2023, and the 2023 Fall Economic Statement proposed to exempt the first $10 million in capital gains realized on the sale of a business to an EOT from taxation, subject to certain conditions. Budget 2024 articulates the qualifying conditions, including those around who the seller can be, what a qualifying transaction is, conditions that are applicable 24 months prior to the sale, a requirement to be actively engaged in the business, and a requirement that the EOT have at least 90% of the beneficiaries be resident of Canada. The budget also indicated that where there are multiple individuals disposing of shares to an EOT, the $10 million exemption must be shared among them. 

The budget also identifies the idea of a disqualifying event. A disqualifying event would occur if the EOT loses its status as an EOT or less than 50% of the FMV of the assets are being used principally in an active business at the beginning of 2 consecutive taxation years of the corporation. Where a disqualifying event occurs within 36 months of the qualifying business transfer, the exemption wouldn’t be available. Where the individual has already claimed the exemption, it would be retroactively denied. If the disqualifying event occurs more than 36 months after a qualifying business transfer, the EOT would be deemed to realize a capital gain equal to the total amount of exempt capital gains.

Additionally, in order for an individual to claim the exemption on a sale to the EOT, the EOT, individual, and the corporation owned by the EOT would need to be jointly and severally liable for any tax owing by the individual in the event of a disqualifying event.

Capital gains exempted through this measure would be subject to an inclusion rate of 30% for the purposes of alternative minimum tax (AMT), similar to the treatment for gains eligible for the LCGE.

These measures would come into force for qualifying dispositions between January 1, 2024, and December 31, 2026.  

Alternative Minimum Tax

AMT is a parallel tax calculation that allows for fewer tax credits, deductions, and exemptions than under the ordinary personal income tax rules. Taxpayers pay either regular tax or AMT, whichever is highest. There was an iteration of the draft rules created in the summer of 2023 which were published for consultation. Budget 2024 proposes that the tax treatment of charitable donations be revised to allow individuals to claim 80% (instead of the previously proposed 50%) of the charitable donation tax credit when calculating AMT. Except for EOTs which are fully exempt, the budget didn’t provide any further relief to trusts, which continue to not have a basic exemption.

These amendments would apply to taxation years that begin on or after January 1, 2024.

Noncompliance with information requests

Budget 2024 proposes several amendments to the information gathering provisions in the Income Tax Act. These proposed amendments are intended to improve Canada Revenue Agency’s (CRA’s) ability to collect information over the course of an audit. 

Some of the proposed tools include the introduction of the “notice of non-compliance” that will impose a penalty on a person who’s been issued this document, amending the Act to allow the CRA to include a requirement that any required information (oral or written) or documents be provided under oath or affirmation, compliance orders with significant penalties, and preventing the stopping of the reassessment limitation clock.

These measures will create more issues and considerations for taxpayers going forward and will be in force upon royal assent.  

Avoidance of tax debts

The Income Tax Act includes an anti-avoidance rule that’s intended to prevent taxpayers from avoiding paying their tax liabilities by transferring assets to non-arm’s length persons. The effect of this rule is to make the transferee jointly and severally or solidarily liable with the transferor for the related tax debts to the extent that the value of the property transferred exceeds the amount of consideration given by the transferee for the property.

Budget 2024 proposes to introduce a supplementary rule to strengthen the tax debt anti-avoidance rule. It would apply where there’s been a transfer of property from a tax debtor to another person at arm’s length to the tax debtor as a single transaction or as part of a series of transactions before being transferred to a person who isn’t at arm’s length with the tax debtor. All parties would be joint and several or solidary liability. The current penalty for tax debt avoidance is the lesser of 50% of the tax avoided or $100,000 plus the fee charged by the arm’s length party. This penalty will now apply to situations captured by the expansion of this rule and  will now include the fee charged by the arm’s length party.

Reportable and notifiable transactions penalty 

The Act includes a general provision that provides that a person who fails to file or make a return or comply with certain specified rules is guilty of an offence and liable to penalties up to $25,000 and imprisonment up to a year. The mandatory disclosure rules in the Income Tax Act also include specific penalties. The government intends to remove the general penalty provision for the failure to file an information return in respect of a reportable or notifiable transaction under the mandatory disclosure rules. This amendment would be deemed to have come into force on June 22, 2023

Homebuyers

Budget 2024 proposes to increase the Home Buyers’ Plan (HBP) withdrawal limit from $35,000 to $60,000. This measure would apply to the 2024 and subsequent calendar years for withdrawals made after Budget Day. In addition, Canadians who make an HBP withdrawal between January 1, 2022, and December 31, 2025, will see their repayment grace period extended by 3 years. These first-time homebuyers will now have up to 5 years before they need to start repayments. The enhanced HBP will work in tandem with the Tax-Free First Home Savings Account (FHSA), which allows Canadians to contribute up to $8,000 per year and up to a lifetime limit of $40,000 toward their first down payment.

Budget 2024 announces that the government will allow 30-year mortgage amortizations for first-time homebuyers purchasing newly constructed homes. This new insured mortgage product will be available to first-time buyers starting August 1, 2024.

Planning point: With its tax-deductible contribution and tax-free qualifying withdrawals and no repayment requirement, the FHSA should still remain your first home purchase savings choice. The expansion of the HBP withdrawal limit may put the Registered Retirement Savings Plan (RRSP) ahead of the Tax-Free Savings Account (TFSA) for higher income earners saving for a home. These contributions are also tax deductible, and the HBP repayment will now begin 5 years after the home purchase. A TFSA can still be a good choice for lower income earners or those who want to avoid the repayment schedule of the HBP.

Secondary Suite Loan Program

To unlock new housing supply, Budget 2024 proposes a new Secondary Suite Loan Program to enable homeowners to access up to $40,000 in low-interest loans to add secondary suites to their homes starting in 2025-26. Whether the loan’s used to bring in a new tenant or to build a space for family members to live close by, this program will help increase density to make the most of available space in communities across the country.

Mutual fund corporations

Mutual fund corporations are generally public corporations with shares that are listed on a designated stock exchange in Canada that are generally widely held. However, a corporation controlled by a corporate group may qualify as a mutual fund corporation even though it isn’t widely held. This could allow a corporate group to use a mutual fund corporation to benefit from the special rules available to these corporations in an unintended manner. Budget 2024 proposes to no longer allow a corporation to qualify as a mutual fund corporation where it’s controlled by or for the benefit of a corporate group (including a corporate group that consists of any combination of corporations, individuals, trusts, and partnerships that don’t deal with each other at arm’s length). Exceptions would be provided to ensure that the measure doesn’t adversely affect mutual fund corporations that are widely held pooled investment vehicles. This measure would apply to taxation years that begin after 2024.

Other measures

Volunteer Firefighters and the Search and Rescue Volunteers Tax Credits ―Budget 2024 proposes to double the Volunteer Firefighters tax credit and the Search and Rescue Volunteers tax credit. As a result, for those individuals who performed at least 200 hours of combined volunteer service during the year, the tax credit will increase from $3,000 to $6,000 for 2024 and subsequent tax years, saving volunteer firefighters up to $900 a year.

Mineral Exploration Tax Credit ―Worth 15% of the specified mineral exploration, expenses incurred in Canada and renounced to flow-through share investors will be extended for one year to flow-through share agreements entered into on or before March 31, 2025.

Canada Child Benefit (CCB) ―An income-tested benefit that’s paid monthly and provides support for eligible families with children under the age of 18. Budget 2024 proposes to extend eligibility for the CCB in respect of a child for 6 months after their death if the individual would have otherwise been eligible for the CCB in respect of that particular child.

Qualified investment rules for registered plans ―Consultations will begin after Budget 2024 to review how the qualified investment rules could be modernized to improve the clarity and cohesion between registered plans. This will include reviewing whether annuities should continue to be qualified and whether cryptoassets should be included, among others.

Canada Pension Plan (CPP) ―The government proposes to amend the Canada Pension Plan to provide a top-up to the death benefit for certain individuals, improve children’s benefits, and end entitlement to a survivor’s benefit following a CPP credit split.

What wasn’t included in the budget?

Budget 2024 didn’t include any further measures around:

• Changes to the dividend received deduction affecting financial institutions
• Increases to marginal tax rates (only capital gains inclusion rates)
• An introduction of a wealth tax 

Conclusion

More details and analysis will have to follow, especially regarding changes to the capital gains inclusion rate and other related changes that didn’t have draft legislation.