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Prime Minister Justin Trudeau, Deputy Prime Minister, Minister of Finance Chrystia Freeland and cabinet ministers pose for a photo before the tabling of the federal budget on Parliament Hill in Ottawa, on Tuesday, April 16, 2024.Justin Tang/The Canadian Press

The federal government is increasing capital gains taxes on wealthy individuals and companies, leaning on an affluent segment of the population to finance billions in new spending on housing and other government priorities.

The federal budget, released Tuesday, increases the inclusion rate on some capital gains. Businesses will now pay income tax on two-thirds of their capital gains earnings, up from one half. The increase will also apply to individuals, but only on capital gains earnings over $250,000.

The change comes into effect on June 25. Lawyers and accountants are expecting a flurry of activity in the coming months, as affected individuals and businesses try to sell assets and realize their capital gains before the new higher inclusion rate takes effect.

The tax measure is expected to net the government $19.3-billion over the next five years – $8.8-billion from individuals and $10.5-billion from companies – in a bid to offset roughly $53-billion in new spending. It’s by far the largest revenue measure in the budget and the first change to capital gains taxes in a quarter-century.

Finance Minister Chrystia Freeland described the measure as an attempt to lean against “structural inequality” and raise funds from wealthy individuals that could be funnelled toward middle class and younger Canadians. The government estimates that the change will impact around 40,000 individuals and 307,000 companies.

However, economists warn that the tax change could dampen investment in Canada and further damage the country’s already-weak productivity growth.

“Perceptions matter,” said Jimmy Jean, chief economist at Desjardins. “A lot of people will be running away with the message that the government doesn’t want to see more business investment, doesn’t want wealthy and highly educated individuals to thrive.”

On the corporate side, the change will mostly impact businesses that buy and sell assets, such as real estate investors or holding companies that invest in publicly traded securities or other businesses.

The budget does include changes that will benefit some entrepreneurs. It increases the lifetime capital gains exemption – which allows small business owners to avoid paying tax on some capital gains when they sell their companies – to $1.25-million from $1-million.

It also introduces a new Canadian Entrepreneurs’ Incentive that lowers the amount of tax some small business owners will have to pay when they sell their companies. Eligible individuals who found and run small private companies will be taxed on only one-third of their capital gains, up to a lifetime limit of $2-million. This will be phased in over 10 years, with entrepreneurs allowed to claim up $200,000 in capital gains at the lower inclusion rate each year.

The new incentive, however, will not apply to a range of industries, including restaurants, hotels and professional services, such as doctors’ offices and small accounting firms.

The changes to capital gains taxation caught economists and experts by surprise. Ahead of the budget, there had been speculation in the business community that the government could introduce an excess profits tax on a broad range of industries, similar to the tax increases on banks and insurance companies introduced in 2022.

That earlier tax measure included a one-time 15 per cent levy on financial institution profits over a certain threshold, and a 1.5 percentage point increase in corporate taxes for those companies.

There was also speculation that the government might introduce a broader wealth tax.

“An adjustment to the inclusion rate is much easier than imposing something like a wealth tax, which has much broader implications to how people manage their lives,” said Darren Hueppelsheuser, a senior partner with the law firm Norton Rose Fulbright. “Whereas the increase in the inclusion rate is a bit more surgical of approach.”

Still, Mr. Hueppelsheuser said the tax changes could impact where investors choose to put their money.

“I think generally people accepted that at 50 per cent capital gain was an attractive way to invest and they were happy to invest their capital. At two-thirds… that could trigger a change in behaviour.”

This was echoed by economists and business advocates who worried the changes could add complexity to the tax system and depress business investment in Canada.

“You’re taxing capital at a moment where the economy needs more private investments and when you have a productivity problem that is worsening,” said Robert Asselin, senior vice-president of policy at the Business Council of Canada. “You’re putting more of a choke point to people investing money in the economy.”

The change in the capital gains tax application will also apply to homeowners with a cottage and investment properties. Homeowners are not taxed when they sell their principal residence. But when a homeowner sells their secondary property, they are taxed on the profit or the difference between what they initially paid for the property and the property’s selling price.

Under the new tax regime announced in the budget, the homeowner would be required to pay the capital gains tax on a higher percentage of their profit.

Christopher Alexander, the president of Re/Max Canada real estate agency, said he has already heard from clients telling him that a higher capital gains tax may force them to hold onto their properties instead of selling them.

Many Canadian homeowners invest in secondary properties to build wealth. “If that was for your retirement or your kid’s education or a vehicle for you to have stability, it is a pretty detrimental blow to your portfolio,” said Mr. Alexander.

Real estate industry experts said hiking capital gains taxes on property sales could have a negative impact on residential real estate developers, undermining the federal government’s attempts to build more homes and bring down house prices.

The new tax “could freeze capital in real estate,” said Michael Brooks, chief executive officer of the Real Property Association of Canada, or REALPAC, a national association of public and private real estate companies. In an e-mail, he said increased taxes on property sales “may work at cross purposes to all these new housing supply initiatives announced over the past few weeks.”

The government expects a shift in behaviour in response to the change. It anticipates an additional $6.7-billion in income taxes in this fiscal year, as people try to realize capital gains before the new inclusion rate comes into effect this summer. It expects additional revenue resulting from the taxation change to decline to $3.3-billion next year and only $375-million the following year, before rising again.

Rob Jeffery, a partner with Deloitte Canada, said he expects companies and wealthy individuals to try to get ahead of the change by selling assets in the coming months.

“To the extent that they were planning on being long-term holders, this shouldn’t matter. But if somebody was planning on a disposition in the next year or two, I think that they’ve really got to look at this and say, ‘Gee, should I accelerate a sale? Should I try to undertake a transaction to save that tax?’” he said.

With files from Andrew Willis

Finance Minister Chrystia Freeland's latest budget projects spending of $535 billion this year, with a deficit of $39.8 billion. She says the spending plan is aimed at creating generational fairness, which will be funded, in part, by changes to capital gains taxes. (April 16, 2024)

The Canadian Press

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