Part 2 – Maybe Not a Capital Idea After All

Welcome back. I assume you’ve already read Part 1, published last week. (CLICK HERE if you haven’t)

The big question: What do I do if…?

This is written more for people who own their own business, particularly in a corporation. But it might be worth a minute, even if you don’t.

Disclaimer: This is simplified, hopefully to add clarity. Your actual situation may vary. Call to discuss.

Q1: I’m selling something now, or plan to sell shortly. What do I do?

Well, depends if you’re exposed to the 67% inclusion rate. If you own the asset personally, don’t worry if you’re not expecting to realize >$250k gains. Otherwise, you’ll pay more tax if the deal closes after June 25. That includes if the asset’s held in a corporation.

If so…. Can you close the sale on or before June 25? It may be worth reducing the price slightly to do so. We can help you run the numbers.

Q2: Wasn’t planning to sell the [investments / rental property]. Should I?

If you’re not thinking of selling the asset…. Well, as I always say – don’t let the tax tail wag the investment (or business) dog. Who knows how long you may want to hold it, or what gains you may be forgoing?

Also, we still don’t have all the details, and these budget proposals are not yet law. Don’t rush into something you may regret.

Q3: I have assets in my corporation that have gone up in value. Should I transfer them to my personal name?, 

[Why might you do this? Well, as an individual, if my gains are less than $250k a year, I only have a 50% inclusion rate.  Not 67%, as per my corporation. So I’ll move them now, so I don’t pay more tax on future gains]

We don’t advise this in 99% of cases. First, you’ll trigger capital gains tax on the disposal from your corporation’s name (there’s no mechanism to transfer from corporate to personal without doing that) – even if it’s at the 50% inclusion rate. That means your corporation will pay CG tax – without actually having received any money from a “real” sale.

Secondly, if you transfer the assets into your own name, you (personally) will have to pay the corporation for the fair value of those assets. Either you’ll have to inject the cash, or it will be a taxable dividend this year – on the entire value.

Thirdly, if you’re transferring a property, you’ll need to re-register title. Which means you’ll have to pay land transfer tax. To add insult to injury. (And don’t forget additional complications for your insurance, your mortgage, and HST implications if it’s a commercial property…. Get the picture?)

All of this without actually having sold the asset and generated cash to pay these taxes.

Finally, you’d lose any other benefits from having the assets in a corporation (eg. protecting against personal liability).

Footnote:  At first glance – without having seen draft legislation – there may be some ways to avoid this. BUT… the mechanism would be complex, it would require significant transaction costs, and there’s no guarantee that CRA would accept it. At this point, I’d say you need to be looking at a gain of at least $1m to consider these more complex alternatives.

Q4: Hmm. OK, I won’t mess with the assets already in my corp. But should I transfer more assets to my corp – or continue to invest in my corp?

We have many clients who’ve spent many years building their business, and who are now in the “harvesting” stage. For many of them, the tax rules – so far – have suggested that they keep much of their wealth within their corporation, rather than taking it out, paying personal tax rates, and investing it personally. The primary reason is that – if you run an active business that generates surplus cash – you can use corporate money (typically taxed only at a max of 26%) to buy those assets. Lots of doctors do this, for example.

Should you continue?

Unfortunately, the answer to this is “It depends”. Some of the relevant factors are:

• What are you planning to invest in, and how long are you planning to hold it?
• Do you think you’ll gain most from income (rent, dividends) or capital appreciation?
• Do you hold any assets personally that may generate ongoing capital gains?

Basically… Continue your current strategy for now. But call us and let’s discuss. Ideally once the new rules have been passed, and we know what we’re looking at.

Q5: I’m planning to sell my business and retire in a couple of years. Will this affect me?

Well, this is a bit mixed. 

Although the inclusion rate went up, the budget also increased the “Lifetime Capital Gains Exemption” from about $1.1m to $1.25m. That’s the amount of gain that – if you meet the criteria – is free from tax, if you sell your business. 

I’ve crunched the numbers… if you want a rough rule of thumb, the increase in the exemption means you’ll pay less tax, if your gain is $2m or less. The rate increase means you’ll pay more tax, if your gain is more than $2m.

The budget also added a further sort-of extension of the exemption (an additional $750k) – but only under certain criteria. The criteria are different from the LCGE mentioned above (especially if you’re an owner but not the founder). So… a good thing, but adds additional complexity.

Final editorial note: What do we think?

I’m a bit conflicted. I see the “social equity” argument for this change.

That said, the wealthiest will find ways around it (because there will likely be ways around it). It’s more likely to hit what I call the “wealth-creating-middle-class” – including those who don’t think of themselves as wealthy.

It’s not great economics, because it’s a disincentive to invest – and we could use more investment. 

And it’s bad tax policy, because it adds even more complexity to a system that’s already overcomplicated. And it creates arbitrariness into how the rules will affect taxpayers.

I’ll close by noting this: In the past 2 years, we’ve twice seen tax legislation passed and implemented – and then walked back, literally on the deadline day. (See my prior posts on UHT and new trust rules. So…. Let’s wait until we see what actually passes Parliament **

Good luck. And… call if you have questions in the meantime!

~ Jules

** If you want my bet…. the rate increase will stay. But the government will extend the 50% bracket to cover the first $250k of gains of private businesses, that are eligible to claim the Small Business Deduction. You read it here first.