The federal government wants to clamp down on incorporated business owners who it says are claiming capital gains when they should be reporting taxable income or dividends.
A capital gain is essentially the increase in the value of a capital asset, such as farmland, above its purchase price.
Under Canada’s tax system, only 50 percent of a capital gain is taxable. Small business owners and farmers are also eligible to claim a lifetime capital gains exemption of up to $1 million.
In this third and final (and maybe most complicated) part of our series on the federal government’s proposed tax changes, we’re going to take a look at how tax rules around capital gains could be changed.
“They’re coming forward with a bunch of rules that are going to prevent an individual from accessing their capital gains exemption or deduction under a number of situations,” explains Jesse Moore, senior manager, tax, with BDO Canada.
In an incorporated farm scenario, these changes could impact intergenerational transfers, including situations where family trusts have been set up to utilize multiple family members’ capital gains exemptions.
Similar to income splitting, the Department of Finance doesn’t want a family unit benefiting by listing family members who haven’t contributed to the business.
To start, the proposed changes would see capital gains accrued before an individual turns 18 no longer qualify for the capital gains exemption.
A reasonableness test would also be applied to determine whether a family member is eligible to claim the capital gains exemption, based on labour and capital contributions and other factors — a grey area that will need to be sorted through, notes Moore. “How do you determine, for a share of a family farm corporation, what portion of the gain is reasonable for the shareholder in light of past labour, capital contributions and that kind of thing?”
Another change would see gains accrued while property is held by a trust no longer qualify for an individual’s capital gains exemption. Many family farms use trusts, not just for tax planning purposes, says Moore:
“(Trusts) are great for estate and succession planning because they give flexibility…so now we’re going to have family trust structures that beneficiaries are going to have problems accessing their capital gains exemption. Now we might be faced with all these trust structures that have to be unwound. A business owner could be faced with having to accelerate their succession or estate plan when they thought they had some time to do so.”
To help transition to the new rules, the Department of Finance has introduced the idea of a one-time capital gain election, to let taxpayers trigger a gain in 2018 and claim a capital gains exemption under the old rules, explains Moore. However, claiming this gain on paper could trigger other real tax costs and impact income-tested benefits, such as Old Age Security and the Canada Child Benefit.
To wrap up, we discuss steps farmers should take at this time, including meeting with tax advisors to discuss scenarios to mitigate some of these issues before the end of the year.
“Sitting around and waiting to see what will happen is probably the worst thing you can do at this point,” he says.
Given how complex these tax policy changes are, there are many more details and potential scenarios that we did not cover in this series, such as differences between transferring capital from a family member versus a non-family member. As Moore recommends, talk to your tax advisor about your specific situation. You can also read the Department of Finance’s consultation document here.
Listen to parts 1 and 2:
- Tax change answers — Part 2: Passive investment income
- Tax change answers — Part 1: Income splitting