How the capital gains inclusion rate increase is going to affect incorporated Canadians.
We’ve never had so many calls and emails in the office about taxes than when the government recently increased the capital gains inclusion rate.
This massively affects Canadian doctors and any incorporated business owner or professional with a holding company.
The changes to the capital gains inclusion rates in the 2024 Canadian Federal Budget could have a significant impact on your tax liabilities and overall financial strategy.
Today, we’re diving deep into these capital gains changes and how they might affect your financial outlook, especially if you’re a doctor or using a holding company to invest.
Capital Gains Inclusion Rates
In Canada, when you sell an asset and realize a capital gain, only a portion of that gain is included in your taxable income—this is known as the capital gains inclusion rate.
Before the changes, the inclusion rate stood at 50% for all capital gains either personally or inside a corporation. Which means that only half of your realized gain is subject to tax at your marginal tax rate.
This has been a beneficial structure for many investors, particularly those who are incorporated and investing in their company.
Now, this increase in the inclusion rate means significantly higher taxes, reducing the overall benefit of such a strategy.
I’m going to focus the rest of this video for incorporated doctors and physicians.
Investing Through a Holding Company
For Canadian physicians, holding companies are a common tool for both investing and tax planning. It’s literally what you were supposed to do for the past 40 years.
By transferring retained earnings from your medical corporation to a holding company via a tax-free intercompany dividend, you can invest in all sorts of assets like stocks or real estate without being immediately taxed personally on those funds.
This allows you to keep more capital working for you right away. But there’s a nuance here: while this strategy offers immediate benefits, the principle of tax integration may reduce its effectiveness over time.
Understanding Tax Integration
Tax integration is a key principle in the Canadian Income Tax Act, designed to ensure that income earned by both individuals and corporations is subject to similar overall taxation.
This helps to prevent double taxation on the same income.
Essentially, the earnings of your medical corporation are taxed at the corporate level, and when those earnings are distributed to you as salary or dividends, you pay personal tax on that income.
With dividends, a personal tax credit on the grossed-up amount balances this out, making sure that the combined tax paid at the corporate and personal levels is basically the same as if the income were earned directly by you.
Proposed Changes & Their Impact
So now the changes in the 2024 Federal Budget have been in place since June 2024.
The government is increasing the capital gains inclusion rate from 50% to 66.67%, effective June 2024.
This change has substantial implications for corporations, including holding companies, by making a larger part of the capital gains taxable.
Consider this hypothetical scenario: me, Dr. Munier, an incorporated physician in British Columbia, has a holding company through which I sell my old office with a realized capital gain of $500,000.
Under previous rules: Only 50% of that gain, or $250,000, is taxable, resulting in a tax liability of approximately $133,750.
Under the new rules: With the inclusion rate increased to 66.67%, $333,350 of the gain becomes taxable, raising the tax liability to approximately $178,342.25.
This represents a 33.34% increase in tax for the same gain. That’s an extra $45,000 in taxes going to Ottawa when Dr me sells my office.
Additional Impacts to Consider
The ramifications of the proposed changes don’t stop at capital gains. They could also affect how passive income is calculated, which in turn could influence the small business deduction limit for connected companies, such as your medical corporation.
On top of that, the tax-free capital dividend account (CDA) could see reduced credits, which could further limit your ability to distribute tax-free dividends. Which means you are paying more tax and more tax again.
Strategies & Considerations
Since the changes to the capital gains inclusion rate have been put in place, it’s important to review and maybe adjust your financial strategies that were set up under the old rules.
Here are some key steps to consider:
Reevaluate Your Investment Strategies:
What are you invested in? Would investing in different types of investments minimize the impact of these changes? Do you have to switch your investment strategy?
Maximize Tax-Deferred Accounts:
So now tax deferred accounts like RRSPs and TFSAs are even more valuable, and it might make sense to max these out even more.
Consider Permanent Life Insurance:
Permanent life insurance policies like whole life insurance and universal life insurance have always had privileged tax treatment, but accountants and lawyers could always do things to help lower your tax bill. Well, the government has taken away a lot of the planning that used to be available, so life insurance becomes a bigger priority strategy.
Permanent life insurance policies can offer both estate protection and tax-deferred growth within your holding company. Growth of cash values inside your life insurance policy also doesn’t count towards the new passive income rules that came into effect a few years ago.
Life insurance can help with the new capital gains inclusion and with the passive income rules – 2 birds one stone.
Final Thoughts
These tax increases are implemented; and they will affect incorporated physicians across Canada who invest through holding companies. The changes probably already affect you as they’ve been in effect for a few months now.
If you haven’t already, now is an important time to talk to your financial team – your insurance person, investment advisor, accountant and lawyer – and potentially adjust your plan based on these new tax inclusion rates.
If you don’t like your insurance guy or don’t have one, we’re happy to talk to you and see if your current plan makes sense or put together a new plan if you don’t have one yet.
Contact Us
At Safe Pacific Financial, we specialize in helping Canadian business owners, incorporated professionals, and investors structure life insurance for maximum wealth protection, tax savings, and business growth.
If you would like to discuss whole life insurance or investments, we’re happy to chat and see if we can be a good fit to work with you. Fill out our contact form and we will get back to you within 24 hours on business days.
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