“It’s just for the wealthy” and other myths about Canada’s new capital gains tax

When Ottawa announced the new capital gains inclusion rate of 66.6%, they promised it would only affect a tiny fraction of Canadians – specifically, “0.13 percent” with million-dollar incomes.

But if you’re a professional with a corporation, someone inheriting the family cottage, or one of Canada’s millions of small business owners, you’re about to discover an uncomfortable truth: the impact of these changes reaches far beyond the ultra-wealthy.

The increased inclusion rate means more tax will be paid

The new capital gain inclusion rules are in effect as of June 2024. The introduction of the new 66.6% capital gains inclusion rate, along with the modifications of the Alternative Minimum Tax, is changing the landscape of how high-net-worth individuals structure their finances.

More people than you think are impacted

The federal government alleges that only a few Canadians will be affected by these changes as they allow individual taxpayers to utilize the previous inclusion rate for the first $250K of taxable capital gain.  They therefore claim that “only 0.13 percent of Canadians with an average income of $1.42M are expected to pay more personal income tax on their capital gains in any given year.”1

In reality, these changes negatively impact a much larger group of working people:

• Anyone with a professional corporation: Doctors, lawyers, accountants, real estate agents, and investment advisors are only some of the professionals who execute their business via a professional corporation (Prof Corp). Many of these professionals do not have a pension program other than CPP and rely on the growth of the investments in their professional corporations to form the basis for their retirement income. Even though many of these corporations pertain to individuals, the individual $250K exemption does not apply to individuals with Prof Corps.

• Estates and Individuals selling large family assets: Between now and 2026, about a trillion dollars will change hands from the Boomer generation to the Millennials. 2 Thousands of cottages and second homes will change hands or be deemed to be disposed of upon the death of the current owners. For those who were hoping to keep the family cottage in the family, the financial barrier just got up to 1/3 bigger, even if the deceased had life insurance to pay for the tax on death – that obligation became significantly larger with little notice.

• Business owners looking to sell or transition their business: Canada is at a crucial time for business owners and entrepreneurs. According to a 2022 study by the Canadian Federation of Independent Businesses (CFIB), 72% of small business owners plan to exit their business within the next 10 years. 3 A KPMG study found that 54% of Canadian family businesses plan to transfer ownership to the next generation within the next 5 years. 4 Upon transfer, the new effective capital gains rate applies to sales and any preferred shares should there have been a freeze. This is a hit to people who have built their businesses over long periods of time. The government has, in effect, taken an extra cut of the proceeds.
  

What can be done?

There is increased interest in alternative asset classes and longer hold periods for quality assets to avoid the additional friction of the capital gains rate increase on disposition. However, one of the most effective solutions to combat the impact of the changes is life insurance.

Life insurance has always been used and thought of as an option to address estate tax – but the benefits are much more extensive than this. The use of permanent life insurance policies is gaining traction because it provides:

Security – At the core, life insurance provides a payout of cash in the case of death – this is especially valuable in protecting the people, and the causes one loves, by providing the means to do what is necessary (e.g. have the liquidity to pay tax, income to support loved ones or charities,  estate equalization, share buy-outs, etc). 

Tax-advantaged growth – Growth up to 8% within the policy is tax-exempt – allowing low friction compound growth on the contributions and the return within the policy. Depending on the policy and options chosen, the death benefit grows over time, providing an attractive risk-adjusted return on the premiums paid.

Tax-free death benefit – Life insurance proceeds are tax-exempt on death, and the CDA provision allows proceeds to be extracted from a corporation tax-free.

Efficient access to cash if needed throughout one’s life – Whole-life PAR policies are treated as an asset for the purposes of borrowing. One can borrow against the cash surrender value of the policy at very attractive rates since most insurance companies have high credit ratings.

How can you help yourself and your clients?

If you or your client are facing a looming estate tax bill, a company sale, or are looking for efficient ways to structure retirement cash flow, life insurance is probably at least part of the answer. More and more Canadians own life insurance. As of 2023, Canadians owned $5.7 trillion, up from $4 trillion just 10 years ago. 5

With more than $14 billion in life insurance managed, we are the largest and most sophisticated life insurance brokerage in Canada.   

Contact our team of specialists to discuss how we will help you help your clients.