Canada - Capital Gains Inclusion Rate Planning

I thought I'd share some analysis I've conducted on the potential impact of Canada's capital gains inclusion rate increase from 50% to 66.7%, and how it could affect searchers and other investors planning to realize a substantial capital gain in the near to medium term. The analysis sought to determine the "point of indifference" between crystallizing a gain and paying taxes today (at the current inclusion rate) versus holding the capital asset and selling it at a later date (at the new inclusion rate). Put simply, how soon after June 2024 would a transaction need to occur for a corporation to benefit from crystallizing the gain before the inclusion rate increases?

Assumptions in the Analysis

Corporate-Level Taxation: The proceeds are taxed at the corporate level (e.g., proceeds from selling capital assets are retained in a HoldCo on a tax-deferred basis and not distributed to be taxed at the personal level).

Financing Cash Taxes: The analysis assumes the required cash taxes for crystallizing the gain are financed at an 8% interest rate, without accounting for the approximately 12 months between crystallizing and paying the CRA.

Key Findings

Assuming a corporate tax rate of 50.67%, the "point of indifference" is 6.33 years.

This means that a corporation would be in a net beneficial tax position for over 6 years by crystallizing the gain today and paying tax at the current 50% inclusion rate, compared to holding on and selling after the increase.

This calculation doesn't include any growth in the underlying value of the capital asset, which can be factored in if needed.

Example Scenario

HoldCo expects to realize a $100,000 gain from selling its OpCo shares to a third party. How soon after the inclusion rate increase (June###-###-#### would the sale need to occur for HoldCo to benefit from crystallizing its gain before the policy change?

If HoldCo triggers a $100,000 gain before the inclusion rate increase and finances the capital gains tax payable at an 8% rate, HoldCo would only benefit if the eventual transaction closed within 76 months###-###-#### years) of the policy change. Each passing month erodes the benefit of crystallizing the gain today due to the net interest cost associated with financing the capital gains tax upfront.

Additional Considerations

Timing: After making the election, you have a grace period to set the new adjusted cost basis of the capital asset. If you decide not to sell or liquidate in the###-###-#### month period (to be confirmed) you have to set the new adjusted cost basis, or if the inclusion rate increase is ultimately not approved by government, you can simply set the new adjusted cost basis equal to the current cost basis, resulting in no change or capital gains taxes owed (you would only be out of pocket the legal/accounting expense required to setup/conduct the tax planning strategy).