For individual investors, the federal budget Thursday doesn't initially appear to deliver much change. A closer look, though, shows there are enough noticeable differences to make investors pay attention.
Largely, investors in Canadian public companies are off the hook. The budget had "a lot of very targeted measures going after perceived loopholes," said John Waters, head of tax and estate planning at BMO Nesbitt Burns Inc. It's a lot of little things, he added in an interview, but "these are big things to a lot of people."
When the budget is approved by Parliament, owners and shareholders of private small businesses and investors hoping to diversify their portfolio from a single security will run into some small, but noticeable, changes. Investors with large foreign holdings or who hold investment funds with certain financial arrangements will notice differences, too.
People who dispose of their shares of qualified small businesses – or farm and fishing property – will see their lifetime capital gains income tax exemption from those dispositions rise to $800,000 from $750,000 for dispositions on or after Jan. 1 of next year.
If you've hit the limit before, you're in luck.
"In a situation where a small business owner has already realized the $750,000 capital gains exemption in the past, starting in 2014, they will be eligible for an additional capital gains exemption of $50,000," said Bobby Hinduja, a financial advisory consultant with Royal Bank of Canada's Wealth Management division, on a conference call to the bank's investment advisers.
The broadest impact of the capital gains exemption changes, though, is that it will be indexed to inflation as of the beginning of next year. This is good news for business owners planning to exit their business down the road.
"Under the current rules, if a business owner plans to sell his business in 20 years, he could be eligible for a capital gains exemption of $750,000," Mr. Hindja said. "But under the proposed changes, if we assume an annual inflation rate of 2 per cent, the capital gains exemption will be worth approximately $1.2-million when the owner sells the business."
It's not all good news for small business owners, though. Shareholders of private companies that are taxed at the small-business rate who receive dividends from owning the business will find those dividends – for tax purposes, classified as "non-eligible" dividends – subject to higher tax.
Those dividends will now be taxed at 21.22 per cent, up about 1.5 percentage points from before.
"This change could have impact on the decisions owner-managers make surrounding compensation from their companies," Mr. Hinduja said. These owner-managers should consult their tax advisers about the changes to see if their compensation mix of salary and dividends is still right for them. (The total impact, Mr. Hinduja noted, won't be clear until provinces also release their budgets this year.)
Older shareholders and small business owners should pay attention to how these changes affect their taxable income and whether government benefits such as Old Age Security payments change as a result. The "gross-up" factor, by which the federal government modifies the amount for which they are taxed, has actually lessened.
Mr. Hinduja points out that $55,000 under the previous "gross-up" rate of 25 per cent would make $55,000 in taxable dividends about $70,000, whereas the new rate of 18 per cent means a taxable amount of $65,000, which changes the amount of OAS clawback a person would have.
Investors in funds that use "character conversion transactions" will see some changes, too. These funds, which Mr. Waters of BMO likens to "a sort of magic box," convert income from interest and dividends into capital gains, which are taxed more efficiently than in their original form. The budget takes measures to prohibit many of these kinds of income conversion.
And people who own a large amount of a single company's shares and wish to diversify or liquidate – such as from selling a company or through stock options – may face more fees. "Some investors [who] have a portfolio whose value concentrated in a single equity security are really asset rich and cash poor," said Allison Marshall, RBC Wealth Management's head of high-net-worth planning services.
Selling all of these shares can be a huge tax liability, Ms. Marshall said on the conference call, and an equity monetization arrangement has historically been used to ease that burden. Here, investors agree to sell their shares at an arranged value, then borrow funds to diversify their portfolio. When that loan matures, so does the contract for selling the shares.
Doing this to avoid a tax burden won't be so easy any more, though. "What the budget is seeking to do is ensure that if you have disposed of securities for economic purposes, but the legal ownership of the property is retained by the investor, they want to ensure that you are not able to defer the capital gains tax on the economic disposition of that property," Ms. Marshall said.
Investors will be directly affected by several other changes, including changed reporting requirements for Canadians with more than $100,000 in foreign property, beginning next year. Everyone will be affected differently by these changes, of course, so it's best to contact your personal tax expert and financial adviser to see how the budget affects your own portfolio or business.