What You Can Do if the Federal Government Increases the Capital Gains Rate in 2022
Although the Canadian government has considered raising the capital gains rate in previous years and declined to do so, some are speculating that increasing debt, campaign promises and the cost of the fight against COVID could mean this is the year the government will increase the capital gains rate. The speculation is that the 2022 Federal Budget will include an increase in the capital gains rate by increasing the capital gains inclusion rate. Currently, the capital gains inclusion rate is 50%. This means you only include 50% of your realized capital gains as taxable income and therefore it is effectively taxed at half the rate of your other income. However, with a capital gains inclusion rate increase to 75% for example, you could find yourself paying much more in taxes.
This would be particularly painful if you are planning a move from Canada after a rate increase and have to pay a departure tax. When you move to another country, you are deemed to have disposed of all your property at its fair market value (FMV) when you cease to reside in Canada. With the possible exception of your residence and some pension plans, this deemed disposition triggers a departure tax on the gain accrued on your property before your departure. That means if the capital gains inclusion rate is increased from 50% to 75%, for example, you could face an additional 50% of departure tax on the accrued gains of your investments.
So is there anything you can you do now to avoid the potential tax increase? While I can’t predict what will be in the 2022 Federal Budget, here are three possible solutions for pre-empting a higher capital gains inclusion rate.
You could actually sell your appreciated investments now and lock in their capital gains tax at the current 50% inclusion rate. This would avoid the risk of paying a higher rate later, however, sometimes it does not make sense to sell an asset for a variety of reasons. Furthermore, it is my belief, the fear of a tax increase should not change your investment decisions.
You could transfer your appreciated investments to your spouse now. Under Canadian rules, the transfer of assets to a spouse is an automatic rollover at the cost base (ACB) of the assets unless you elect to transfer at the FMV.
If the capital gains inclusion rate increases in the 2022 budget, you can elect out of the automatic rollover. The transfer will be reported on your 2022 income tax return as a taxable transaction that triggers a capital gain at the current 50% inclusion rate. The ACB of the assets to your spouse will be the investments’ FMV. Your spouse will report the deemed disposition of the investments in his or her departure tax return with no gain or loss.
If, on the other hand, the capital gains inclusion rate does not increase, the transfer will be reported on your 2022 income tax return with no capital gain due to the automatic rollover. Although your spouse will own the securities at the time of departure from Canada, you will still need to report the deemed disposition to report the capital gains at departure at the 50% inclusion rate due to the Canadian attribution rules.
If you do not have a spouse, you could transfer your appreciated investments to a Canadian holding company (Holdco) in exchange for shares of the Holdco with FMV equal to the FMV of the investments being transferred now.
If the capital gains inclusion rate increases in the 2022 budget, you do not need to do anything. The transfer will be reported on your 2022 income tax return as a taxable transaction that triggers a capital gain at the current 50% inclusion rate. You will then report the deemed disposition of your Holdco shares at departure with no capital gains or losses.
If, on the other hand, the capital gains inclusion rate does not increase, you and your Holdco can jointly elect that the investments be transferred for tax purposes at their ACB under section 85 of the Income Tax Act. Your ACB of the Holdco shares will be the original ACB of the assets transferred. You will then report the deemed disposition of your Holdco shares at departure with capital gains.
If the possibility of a capital gains inclusion rate increase has you worried, it may make sense to consult a cross border tax advisor. Depending on your situation, MCA can help you implement one of the strategies described here or customize one for you. Request a consult if you’d like to learn more about minimizing your tax burden before a cross border move.