Show Transcript
If you’re a business owner, the federal government’s proposed changes to the capital gains rules may raise questions about your retirement and your ability to grow your business. Pierre Létourneau, Business Succession Advisor, TD Wealth, joins Kim Parlee to talk about ways to navigate the new rules and whether you should be rushing to make any moves.
Print Transcript
* The new capital gains tax rules in the latest federal budget is something business owners are closely watching, whether they run a medical practice, a hair salon, or even a trucking company. Pierre Létourneau is Business Succession Advisor at TD Wealth. He joins us now with more.
- Nice to see you. We've been talking about this for years, and it's finally happening. So maybe just talk about a bit what happened and what business owners need to think about. And I know you have an example.
* Yes. Yes, I do. So what happened here is that the capital gains inclusion rate increased from 50% to 2/3. And, essentially, what that means for business owners is they'll now be paying more taxes on capital gains they earn inside their corporation starting June 25.
* Right.
* And with individuals, there is a threshold that needs to be met before the new inclusion rate applies, and that's $250,000. That doesn't apply to corporations. Dollar one in capital gains will be subject to the new inclusion rate.
* Which is a lot.
* Yes. And we've got an example to show you exactly how that translates. So this is an Ontario corporation that bought capital assets at $1 million and sold it for $2 million, generating a capital gain of $1 million. So under the current rules, only 50% of that capital gain is included in income, so that's $500,000.
- And so at corporate tax rates in Ontario on taxable capital gains is just around 50%, so you're looking at taxes of about $250,000. Under the new rules, 2/3 of that capital gain is included in income. So when you apply that same tax rate, you're now looking at almost $335,000 of taxes payable. So that's a difference of almost $84,000 in this example.
* Yeah, which is big. It is a big number.
* It's a big number.
- Yeah. It also will have an impact on the capital dividend account, which attracts tax-free amounts that a corporation receives and then allows the corporation to pay those tax-free amounts as tax-free capital dividends to its shareholders. Now, with the capital gain, the tax-free component is added to the CDA.
- Now, with the higher inclusion rate, that means less of the percentage of the capital gain is tax-free. So that's going to provide less opportunity for business owners to extract tax-free amounts from their corporation.
* Yeah. Medical professionals have been quite vocal about this in the past few days in terms of what it means. How might these changes affect them?
* So, many medical professionals and other professionals, like lawyers and accountants, they operate their practices through professional corporations. And one of the reasons they do that is there is a tax benefit to doing that. It's a tax deferral benefit.
- For any income that they don't need personally, they can keep it inside the corporation, pay less tax, because they're only paying corporate taxes, and it allows them to build a retirement nest egg. Remember, a lot of these professionals don't have employer-paid pensions. So this is really how they save for retirement. What do they do with those funds? They invest those funds.
- Part of the income generated from those investments are capital gains. That will be taxed at a higher rate. So that will leave less for them for retirement.
* Yeah, which is big. That's a big one for them too. Yeah. Do you think it could actually, and we did hear in some media, deter people about thinking starting these, we say professional corporations, or deter founders, tech workers-- a lot of people use these corporations.
* Right. And I think it can have an impact. I think the theory behind lower tax rates for capital gains is that it would provide an incentive to entrepreneurs to invest in businesses and take on that risk that you're taking on when you're starting a business. Well, if that incentive is reduced, then you may not want to take on that risk. So I think you'd want to maybe allocate your capital in a different way.
* I know that in the budget, there's always puts and takes as they try and get people to understand. And I know there was some thing that maybe part of it could be to offset some of the things that were proposed earlier or just to provide, like I said, the put to the take, this is the Lifetime Capital Gains Exemption. What happened there? And does it provide an offset?
* So, yeah, so what happened there is they increased the exemption. So it's just over $1 million now. So they're increasing it to $1.25 million. And yeah, it's nice to see that, but it's not something that will offset the inclusion rate, because this is really only available on specific circumstances.
- And for business owners, that's when they sell shares of a private company-- but not just any private company. It has to be shares of a qualified small business corporation. So to meet that test, a corporation can't have too much passive assets. There's a lot of tests that need to be met. And when a business owner sells their business, they're not necessarily going to be able to sell the shares. Sometimes they sell the assets. So this exemption may not be available.
- There's also the Canadian entrepreneurs incentive as well, too, that was proposed. Again, nice to see, but also very limited in terms of the circumstances that this will be used. So I think it won't fully offset because it is quite restrictive.
* OK, so the capital gains tax inclusion rate was broad, and these are very specific. And that's kind of the offsets. Business owners who are listening to this right now thinking, OK, let's rush and go do something right now to make sure that we do something before that date-- and you're saying, just wait?
* Yes, don't rush. But there could be a tax planning opportunity here. And I think the government is kind of banking on that. They've given you a bit of time to digest this and maybe react.
- But, yes, I think some business owners are going to look at accelerating capital gains. Now, that means they pay more taxes now, but they can lock in that lower inclusion rate.
- There's a lot of pros and cons of doing that. With business owners, you've got to be mindful, because if you're triggering capital gains, you're increasing your passive investment income, which may impact your small business deduction if you're generating active business income. So small business deduction is a preferential tax rate that's available on the first $500,000 of active business income. So you may be doing something that's good from a passive investment income standpoint, but you may inadvertently be triggering taxes on active business income. So you've got to weigh that out.
* I'm sure, has your phone been ringing since you've been doing this?
* It has. It has. It's been busy. It's been busy.
* So people just need to talk to someone, because, really, this is a customized situation.
* Exactly. You need to run the model, look at different scenarios. And we don't have all the information also. That's a good point to make, because there's still legislation to be released. And so working closely with someone will help identify when that legislation does come in, we know exactly how this is going to work.
[MUSIC PLAYING]
- Nice to see you. We've been talking about this for years, and it's finally happening. So maybe just talk about a bit what happened and what business owners need to think about. And I know you have an example.
* Yes. Yes, I do. So what happened here is that the capital gains inclusion rate increased from 50% to 2/3. And, essentially, what that means for business owners is they'll now be paying more taxes on capital gains they earn inside their corporation starting June 25.
* Right.
* And with individuals, there is a threshold that needs to be met before the new inclusion rate applies, and that's $250,000. That doesn't apply to corporations. Dollar one in capital gains will be subject to the new inclusion rate.
* Which is a lot.
* Yes. And we've got an example to show you exactly how that translates. So this is an Ontario corporation that bought capital assets at $1 million and sold it for $2 million, generating a capital gain of $1 million. So under the current rules, only 50% of that capital gain is included in income, so that's $500,000.
- And so at corporate tax rates in Ontario on taxable capital gains is just around 50%, so you're looking at taxes of about $250,000. Under the new rules, 2/3 of that capital gain is included in income. So when you apply that same tax rate, you're now looking at almost $335,000 of taxes payable. So that's a difference of almost $84,000 in this example.
* Yeah, which is big. It is a big number.
* It's a big number.
- Yeah. It also will have an impact on the capital dividend account, which attracts tax-free amounts that a corporation receives and then allows the corporation to pay those tax-free amounts as tax-free capital dividends to its shareholders. Now, with the capital gain, the tax-free component is added to the CDA.
- Now, with the higher inclusion rate, that means less of the percentage of the capital gain is tax-free. So that's going to provide less opportunity for business owners to extract tax-free amounts from their corporation.
* Yeah. Medical professionals have been quite vocal about this in the past few days in terms of what it means. How might these changes affect them?
* So, many medical professionals and other professionals, like lawyers and accountants, they operate their practices through professional corporations. And one of the reasons they do that is there is a tax benefit to doing that. It's a tax deferral benefit.
- For any income that they don't need personally, they can keep it inside the corporation, pay less tax, because they're only paying corporate taxes, and it allows them to build a retirement nest egg. Remember, a lot of these professionals don't have employer-paid pensions. So this is really how they save for retirement. What do they do with those funds? They invest those funds.
- Part of the income generated from those investments are capital gains. That will be taxed at a higher rate. So that will leave less for them for retirement.
* Yeah, which is big. That's a big one for them too. Yeah. Do you think it could actually, and we did hear in some media, deter people about thinking starting these, we say professional corporations, or deter founders, tech workers-- a lot of people use these corporations.
* Right. And I think it can have an impact. I think the theory behind lower tax rates for capital gains is that it would provide an incentive to entrepreneurs to invest in businesses and take on that risk that you're taking on when you're starting a business. Well, if that incentive is reduced, then you may not want to take on that risk. So I think you'd want to maybe allocate your capital in a different way.
* I know that in the budget, there's always puts and takes as they try and get people to understand. And I know there was some thing that maybe part of it could be to offset some of the things that were proposed earlier or just to provide, like I said, the put to the take, this is the Lifetime Capital Gains Exemption. What happened there? And does it provide an offset?
* So, yeah, so what happened there is they increased the exemption. So it's just over $1 million now. So they're increasing it to $1.25 million. And yeah, it's nice to see that, but it's not something that will offset the inclusion rate, because this is really only available on specific circumstances.
- And for business owners, that's when they sell shares of a private company-- but not just any private company. It has to be shares of a qualified small business corporation. So to meet that test, a corporation can't have too much passive assets. There's a lot of tests that need to be met. And when a business owner sells their business, they're not necessarily going to be able to sell the shares. Sometimes they sell the assets. So this exemption may not be available.
- There's also the Canadian entrepreneurs incentive as well, too, that was proposed. Again, nice to see, but also very limited in terms of the circumstances that this will be used. So I think it won't fully offset because it is quite restrictive.
* OK, so the capital gains tax inclusion rate was broad, and these are very specific. And that's kind of the offsets. Business owners who are listening to this right now thinking, OK, let's rush and go do something right now to make sure that we do something before that date-- and you're saying, just wait?
* Yes, don't rush. But there could be a tax planning opportunity here. And I think the government is kind of banking on that. They've given you a bit of time to digest this and maybe react.
- But, yes, I think some business owners are going to look at accelerating capital gains. Now, that means they pay more taxes now, but they can lock in that lower inclusion rate.
- There's a lot of pros and cons of doing that. With business owners, you've got to be mindful, because if you're triggering capital gains, you're increasing your passive investment income, which may impact your small business deduction if you're generating active business income. So small business deduction is a preferential tax rate that's available on the first $500,000 of active business income. So you may be doing something that's good from a passive investment income standpoint, but you may inadvertently be triggering taxes on active business income. So you've got to weigh that out.
* I'm sure, has your phone been ringing since you've been doing this?
* It has. It has. It's been busy. It's been busy.
* So people just need to talk to someone, because, really, this is a customized situation.
* Exactly. You need to run the model, look at different scenarios. And we don't have all the information also. That's a good point to make, because there's still legislation to be released. And so working closely with someone will help identify when that legislation does come in, we know exactly how this is going to work.
[MUSIC PLAYING]
