How to prepare for a potential tax hike on capital gains

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The threat of a higher capital gains tax rate is resurfacing in conversations between financial advisors and their clients as Ottawa looks for ways to pay down a soaring deficit amid billions in spending on pandemic-relief measures.

There has been speculation ahead of each federal budget in recent years that the Liberal government will increase the so-called capital gains inclusion rate, currently at 50 per cent, which is the percentage of capital gains included in taxable income. However, advisors say the unprecedented spending on COVID-19 programs, which has pushed the projected size of the deficit to almost $400-billion, makes a capital gains tax increase more likely.

“I wouldn’t be at all surprised if we see that in the coming budget,” says Rona Birenbaum, founder and certified financial planner at Caring for Clients, a fee-for-service financial planning firm in Toronto.

That’s despite Prime Minister Justin Trudeau telling Radio-Canada recently that “it’s certain,” his government “will not impose more on Canadians” when he was asked if he could pledge that there won’t be any income or other tax hikes.

“If 2020 taught us anything, it’s that nothing is certain,” Ms. Birenbaum says.

Jamie Golombek, managing director, tax and estate planning, at Canadian Imperial Bank of Commerce (CIBC) in Toronto, is encouraged by Mr. Trudeau’s promise not to increase taxes, but cautions that politicians “have a way of changing their minds down the road, especially if the economy worsens.”

He also cites CIBC research showing a hike in the capital gains inclusion rate will only affect about 10 per cent of Canadian taxpayers, making it less risky politically than other speculated moves such as an increase to the Goods and Services Tax.

“The capital gains inclusion rate is by no means a sacred cow, and I suspect it is perpetually on the table as a way to increase tax revenue without having to increase personal marginal tax rates,” says Jason Nicola, a financial advisor at Nicola Wealth Management Ltd. in Vancouver.

He reminds investors that there was no capital gains tax until 1972, when it was introduced at the 50-per-cent rate. It was then increased to 66.67 per cent in 1988 and then to a high of 75 per cent in the 1990s. In 2000, it dropped twice, first to 66.67 per cent and then to 50 per cent, which is where it stands today.

Mr. Nicola, like most advisors, says speculation about a tax increase alone shouldn’t be enough to spur long-term investors to sell assets.

“I wouldn’t recommend triggering a capital gain solely because you fear the capital gains inclusion rate will go up,” he says.

However, Mr. Nicola says investors thinking about selling taxable assets in the near term, such as non-registered stocks or a secondary residence, might consider acting before the budget, which is usually released in March or April each year.

“If you’re concerned, the approach is to look for opportunities to accelerate planning or trading that you are already considering, but not just because you’re concerned about [an increase in capital gains tax rates],” he says.

For example, he says investors looking to sell a high-flying stock that they believe won’t continue to rise, might wish to sell now rather than later, “but it would have to be backed up by your overall investment thesis.”

Ms. Birenbaum agrees investors should only sell assets sooner rather than later if it’s part of their business, retirement or estate plans.

“Everyone should be looking at their plans for [the coming] year. If they would need to sell investments that trigger a capital gain, it might be worth selling ... before the next budget just to mitigate the risk,” she says.

Examples include clients who are in the process of selling the shares of their private business, or those who need to sell appreciated taxable assets for estate planning or to shore up cash for a major expense, such as helping their kids buy a home.

Mr. Golombek says one tax-efficient strategy for individuals to realize capital gains is selling the securities to a new or existing Canadian holding company in exchange for shares with an equivalent fair market value. The transaction requires careful planning, and advisors should discourage clients from going this route without the help of tax and legal advisors.

In general, he says if there isn’t a case to sell an asset before a potential tax-rate increase, “the fear of such an increase shouldn’t change your investment decision. As we often say, ‘Don’t let the tax tail wag the investment dog.’”

Still, Ms. Birenbaum says advisors need to discuss the possibility of a capital gains tax increase with their clients, even if it’s only speculation at this point.

“Even if the decision is to do nothing, at least you’ve had the conversation,” she says.