The Decibel - The capital gains tax, explained

Episode Date: April 22, 2024

When the federal government released their 2024 budget last week, they changed the capital gains tax for the first time in a quarter-century. The tax is set to bring in $19.3-billion dollars, and the government says it’ll only impact the wealthiest of Canadians. But many are disputing that.Salmaan Farooqui, a personal finance reporter with the Globe’s Report on Business, is on the show to tell us about the basics of capital gains and how this tax might affect Canadians.Questions? Comments? Ideas? E-mail us at [e-mail]

Last week, the federal government introduced an important tax change in the budget. It has to do with taxes on capital gains, and it's expected to bring in around $20 billion. The government says the tax will target just 40,000 of the wealthiest Canadians, but many people are disputing that. Salman Faruqi is a personal finance reporter with the Globe's Report on Business. And today, he explains what a capital gains tax is, what's changing, and how it might impact Canadians. I'm Maina Karaman-Wilms, and this is The Decibel from the Globe and Mail.

Sal, thank you for being here. Thanks for having me. It's great to be back. I think we really just need to start with some basics today. And the basic first question here, Sal, is what is a capital gain? Yeah, I mean, who doesn't love talking about the intricacies of tax, am I right? And so capital gain is essentially the money that you make on an investment that you've bought. So the easiest way to describe that is, say you bought $10,000 of a certain stock and that gained up to $20,000 of value by the time you sold it.

When you sell that stock, the capital gain is that extra $10,000 basically. And that is kind of the amount that they're taxing when we talk about taxes and capital gain. Okay. And so you use the example of stock there, but what else would be included as a capital gain? Basically, the kinds of investments that most Canadians would be dealing with when dealing with capital gains would be stocks, it would be investment properties, secondary properties that basically aren't the home that they live in, or it could even be kind of the business that they're selling. That could also be included in capital gains if that business increases in value. So those are kind of the main areas where Canadians are going to deal with capital gains taxes. Okay. And you did specify here, but this

is just an important point here, primary residence, your house, selling that, the money you make from that is not included. That's not a capital gain. Exactly. It is untaxed if it's your primary residence. So you would not be paying any sort of capital gain on, say, the home that you bought for yourself to live in. Okay. We're going to talk about the change that was announced. But first, let's just establish, how does a capital gains tax actually work in Canada? So currently, 50% of your capital gains are taxable. And that doesn't mean that you're being taxed on 50% of whatever money you made. It means that 50% of those gains are going to count as income, which is then going to be taxed based on your income tax rate.

And that's kind of decided by how much money you made that year. So to kind of give you an example, again, let's say you made $10,000 on that stock that you bought. You bought it at $10,000 and sold it at $20,000. So the 50% rule basically means that $5,000 of that is going to be counted as income. And then that is going to be added to your total income on your tax return. And your tax rate will be sort of decided based on what your total income is. And I believe the term for this is the inclusion rate, right? The inclusion rate in Canada right now is 50%. So 50% of your capital gains are added

to your income. That is correct. And I do want to talk about just, I guess, what we've seen in the last few decades with the inclusion rate, because I recently learned that it actually has changed quite a bit over the last couple decades. Can you just tell us a little bit about that? Yeah, no, I actually was surprised to learn about that myself. I wasn't super aware of that before I started reporting on this story. But before the capital gains tax was set to 50%, just over a couple decades ago, it was actually at 75%. And before that, it was also at 66%. So it's definitely not something that has stayed stagnant. And it kind of points to the fact that this move isn't, you know, it's not a significant, massive change,

a lot of experts would say. And I thought it was also really interesting that when it was 75%, that was actually a move by progressive conservative leader Mulroney. He brought it up to 75% in the 90s. And then Kretchen's liberals brought it down in 2000 to 50%. So it's not even like a partisan thing here. Different parties move it in different directions. Yeah, absolutely. Not necessarily. And, you know, when the liberals brought it back down to 50 percent in the 2000s, the idea was they wanted to spur kind of more people to actually invest for their future. So that was the idea around that decrease at the time. So, you know, things have changed and it hasn't always been a partisan issue for sure. All right. So let's get into what came out of the recent federal budget. So what is the change that

is coming to the capital gains tax? So basically, for most Canadians, they're not going to see much of a change year to year because your capital gains are going to remain at a 50% inclusion rate if you have capital gains under $250,000. Now, when you get to above $250,000, those capital gains are going to start being taxed at a 66% inclusion rate. So the idea here is this is going to bring in more tax revenue from some of the wealthiest Canadians who regularly make that much money in capital gains. The change for businesses is a whole kind of medley of changes to also try and tax businesses at a higher rate, but also exempt some smaller businesses from that tax increase. So generally speaking, corporations are now going to pay a flat 66% inclusion rate on all their capital gains for any dollar event. So there's no $250,000

exclusion anymore. Okay. And when is this change coming into effect? This change is going to come into effect June 25th, which is also an interesting thing because Canadians have around two months right now to maybe sell off their assets if they want to and be excluded from this 66% inclusion rate. How much more would someone be paying because of this change? Can we go through an example, Sal? So I talked to Aaron Hector, who is a Calgary-based financial planner with CWB Wealth, and he ran some calculations on this on budget day. And if we were to use an Ontario resident as an example and assume that they were already in the highest income tax rates, they would pay around tens of thousands of dollars more in taxes. So

here are some examples. Basically, if you were to make $500,000 in capital gains, your old tax under the current rules would be just over $133,000. And under the new rules, it would be $156,000. So that's an increase of $22,000. For someone who made a capital gain of a million dollars, then their tax under the old rules would be just over $267,000. And the new tax would be just over $334,000. So that's a difference of nearly $67,000. Okay. Okay. That gives us kind of a sense, at least, of how this might play out for someone. I also, I want to ask you about tax-sheltered savings accounts, right? Things like RRSPs and TFSAs. How do they factor into this? So this is kind of one of the largest reasons why your average Canadian really isn't

going to be largely affected by this change because the vast majority of Canadians do most of their investing through these tax-sheltered accounts. So, you know, we're talking about registered retirement savings plans, your RSPs and tax-free savings accounts, TFSAs as two examples. People have throughout their careers and lives, they gain hundreds of thousands of dollars of contribution room that they're allowed to put into these accounts. And basically the way it works is these accounts are exempt from capital gains taxes. So if you were to invest in a TFSA and you had, you know, tens of thousands or hundreds of thousands of dollars of capital gains over your lifetime, those are completely untaxed. And, you know, with the contribution room being fairly high, there is a good chance that most Canadians aren't really going to see the kinds of capital gains that you would need to actually be

affected by this tax increase. Yeah, so this is a really important point. So if you invest within your RRSP or TFSA, you're not going to have to really worry about this because these are already exempt from the capital gains tax. Yes. And so when we talk about RRSPs, TFSAs, other tax sheltered accounts that Canadians have access to, there are certain things that they can't invest in through those accounts. That includes housing. So if you're investing in a home, it's not like you can use your TFSA to shield you from some of the capital gains tax. And there are other sort of asset classes such as cryptocurrency that also is not eligible to be used in a RRSP or a TFSA. So there are some methods of investment that Canadians don't really have an option to shield themselves from capital gains tax. And housing is certainly kind of one of them. And that's what the experts I spoke to kind of highlighted as probably the most likely way that middle class Canadians are going to be affected by this tax.

The federal government said that this would only impact the wealthiest of Canadians when they announced this measure in the budget. Sal, is that accurate? I mean, it is largely going to affect the wealthiest of Canadians. The wealthiest Canadians are the ones who make the most money from these kinds of capital gains, and they make a much larger amount that maybe often will go over that $250,000 threshold. But at the same time, there is, you know, part of the middle class out there that might own properties like a cottage, or that maybe were very frugal and saved a lot of money and amassed lots of capital gains throughout their lives. And towards the end of their lives want to make a large withdrawal who could fall kind of over the threshold. And so there is kind of this opportunity for a

one-time tax hit. This is what the experts I spoke to called it sort of when you have a big financial event in your life, there could be a one-time tax hit that, as I mentioned with the numbers before, could be to the tune of tens of thousands of dollars. We'll be back in a moment. So how would a middle class Canadian, how would they be impacted by this new tax change? Like, let's let's go through an example. Yeah, let's say let's say your family owns a cottage. That's not exactly an outrageous thing to own, especially if your family bought one in the 80s or something like that. But those values have obviously gone. They've skyrocketed over the last couple decades. So to have a capital gain on that secondary property of around $500,000, $750,000,

you know, that's not unheard of. And I think there are a lot of middle class Canadians who kind of fall into that category. Or if you're a Canadian who, say, bought an investment property, especially in the past couple of decades when it was a little more affordable, those, again, are the kinds of properties where you can see those large capital gains. So, again, that's where I kind of mentioned that sort of one time financial event, those large financial events in your life, this is kind of where middle-class Canadians could be affected. Yeah. So yeah, so that one-time event you're talking about is like selling a cottage or a property, right? That's when you would face the capital gains tax. And that's really when this happens, right? When you sell something.

Yeah, exactly. So it's the same with if you amassed a large amount of retirement savings over your life that were outside of an RRSP, you're only taxed on that gain once you withdraw the money or sell the stock. Yeah. There has been a lot of talk, particularly in the tech industry, I believe, around how this will really impact stock options. Can you explain that, Sal? Yeah. So from my understanding of this, if you have stock options as part of your compensation package, then the gains in those stock options would be treated the same as gains on any other investment. But again, if you have contribution room in those tax-sheltered accounts like we've talked about, and the stock options or whatever is involved in your compensation package is eligible to be in those accounts, then you can be sheltered from those taxes.

But it is something we've seen, especially in the tech industry, that stock options are a large part of compensation in that industry. And so there are concerns about maybe sort of those highest earners, those real smart minds that are driving innovation in this country, whether they might look at this and be a little dissuaded from the higher tax they'll pay. Of course, you know, to make $250,000 in a year with stock options, I mean, that's pretty good, right? So there's probably not a huge number of people that are actually hitting that number.

Absolutely. Again, I mean, what the experts I spoke to were saying is basically, you really need a portfolio of around, you know, a million or millions of dollars to really see these kinds of gains on a regular basis. So we're talking about some pretty wealthy people who would who would really face regular tax consequences from this. You mentioned kind of, you know, people talking about how this might be like a disincentive for the tech industry as well. Sal, I guess what do you make of that concern? You know, it's been talked about in general for multiple industries. There's concerns about how this will affect investment attitudes, whether people will be less inclined to invest in Canadian businesses. So that's definitely a concern that we've kind of seen out there.

But other experts I've spoken to have also pointed out that it's a relatively small increase at the end of the day. It's a very targeted increase. And again, I mean, the capital gains inclusion rate was at 75% for a fairly long time. And it's not like the country collapsed around that either. So there are definitely disagreements and arguments going on around whether this is the right move from an investment side. But there are definitely arguments on both sides still, basically. Yeah. So, Sal, let's walk through some examples, these kind of once-in-a-lifetime events that you mentioned that some middle-class Canadians might face. So let's talk through some of them. The first one we should address when someone passes away, right? So how would this new capital gains tax impact things like estate planning? With estate planning, the

biggest thing is that when someone dies, your stocks or your investments are realized at that time. They're effectively treated as sold. And so if that was to happen when someone had a million dollars of capital gains in a portfolio, then they could be facing tens of thousands of dollars of higher taxes. So one of the pieces of advice I had heard, or from one of the experts I spoke to, is that people in old age are going to kind of have to look at different strategies if they have those kinds of gains in their portfolio. That might include maybe withdrawing some of their money earlier. Because if you withdraw $250,000 of your assets each year, then you're not going to be affected

by this change, right? Because you'll still be under the $250,000 threshold. On the other hand, there's obviously the fact that if you're taking out your investments over a course of five years, that could be five years worth of gains that you're missing out on as those investments increase in value. So that'll kind of be a conversation that people who are worried about this will really have to have with their advisors for sure. Yeah. So if someone does die, though, and all their assets are realized, as you say, at once, it basically could mean the people inheriting the estate, obviously, if it crosses that $250,000 threshold, the people inheriting the state could get a little less then. Absolutely. The beneficiaries could stand to lose from this.

And that is definitely something that people are going to want to mitigate as much as possible. Let me ask you about retirement then as well, Sal. How could this tax change impact someone who is looking to retire? If you're someone who was lucky enough to invest large amounts outside of tax-sheltered accounts, then you could be facing a larger tax bill when you withdraw some of this money and use it towards your retirement funds. And as well for small business owners who maybe are hit by the larger tax on their capital gains, they could see kind of their plans for retirement affected because maybe they weren't expecting to lose those tens of thousands of dollars,

or maybe in some cases, hundreds of thousands of dollars if they had a very successful business. So that would be if someone had a small business and they're looking to sell it, maybe as part of their retirement plan, this could affect them then? Yeah, for sure. Of course, the government did try to, I guess, blunt some of this concern because they brought in this Canadian entrepreneurs incentive in the budget as well. And they changed the lifetime exemptions essentially for small businesses. So can you just explain that too as well, Sal? Yeah. So these were two

measures that essentially tried to shield smaller businesses from the effect of these capital gains tax increases. So the first is a lifetime capital gains exemption, which is basically, in the current rules, roughly $1 million of your capital gains on your business is exempt from capital gains tax. That has been increased to $1.25 million. And for the Entrepreneur's Incentive, the inclusion rate is basically going to drop to 33% for the first $2 million of capital gains when selling a qualifying business. And there are some exemptions to the kinds of businesses that will qualify under this program. But again, the idea is for sort of smaller businesses to not be affected by this increase in tax as much. But this is a good point that you raised,

though, that a lot of businesses are exempt from this situation. So restaurants, hotels, right? Some professional companies like doctor's offices are exempt from this, so they wouldn't actually get this benefit. Yeah, that's correct. So Sal, we've talked a lot about what this means, but I guess I want to ask you, why did the government choose this measure? Like we know they needed to pay for a lot of spending that they outlined in the budget, but what other options do they have to raise funds? And why did they go this way? Yeah, I mean, in the lead up to this budget, the government was talking a lot about some of the

measures they were going to take and the spending they were going to do in this new budget. And so there was definitely a lot of speculation about how they were going to increase taxes and what avenue they would take. And one of the experts I spoke to basically called this method the less bad method of increasing taxes. And the reason why is, I mean, compared to a wealth tax, which is one of the things that people were concerned about, it's a much simpler thing to introduce. A wealth tax is something that we've seen other countries in the Western world try to implement and actually walk back on

because it can be pretty difficult to create the framework around that kind of tax. And compared to an excess profits tax, which has also been kind of talked about here and there, especially for corporations in the grocery world, which have seen large profits at this time of inflation, there was a lot of concern about that kind of tax as well, because that could put a real chilling effect on investment into Canadian companies, especially if there is sort of less incentive for them to do particularly well. So this is kind of maybe one of the ways to increase tax with the least collateral damage. And it is very targeted at a very small portion of the population in general. So, you know,

this is targeted for wealthier individuals for the most part. And I guess at the end of the day, what you think of this is also what you think of where the liberals direction kind of on the budget this year and how much spending they've decided to do. But if that is something that you are supportive of, then this tax does seem to be kind of the best way to raise revenue compared to some of the other taxes that we talked about. Sal, thank you so much for taking the time to explain all of this today. Absolutely. Thanks for having me. It's been a pleasure. That's it for today. I'm Maina Karaman-Wilms. Our intern is Raisa Alibi. Our producers are Madeline White, Cheryl Sutherland, and Rachel Leaman-Wilms. Our intern is Raisa Alibi. Our producers are Madeline White,

Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show. Adrian Chung is our senior producer, and Angela Pachenza is our executive editor. Thanks so much for listening, and I'll talk to you tomorrow.