While the proposed increase to the capital gains inclusion rate raises the tax floor for investors, the decision to sell assets before the June deadline requires a careful calculation of opportunity costs.

The Mechanics of the Inclusion Rate

A capital gain occurs when you sell an asset for more than its adjusted cost base—essentially the purchase price plus acquisition expenses. In Canada, we do not tax the full amount of this gain. Instead, we use an 'inclusion rate' to determine what portion of that profit is added to your taxable income for the year. Since 2000, that rate has sat comfortably at 50%. However, the 2024 federal budget proposes a shift that harkens back to the 1990s, raising the inclusion rate to two-thirds (approximately 66.7%) for certain taxpayers.

For individuals, this higher rate only applies to capital gains realized in excess of $250,000 in a single year. This threshold offers a buffer for the average investor selling a few stocks, but it will create a significant tax event for those selling secondary properties, businesses, or large non-registered portfolios. It is particularly impactful in the year of death for a second spouse, when all personal gains are 'deemed realized' at once, often pushing the estate well past that $250,000 limit.

The Corporate Disadvantage

While individuals receive a quarter-million-dollar 'safe harbor' at the old rate, corporations—often used by small business owners and professionals for their investments—are not so lucky. Under the new proposal, corporations will be taxed at the higher two-thirds inclusion rate on their very first dollar of capital gains. There is no $250,000 threshold for corporate entities.

By my calculations, a capital gain realized within a corporation and eventually flowed through to a shareholder in Ontario will now face a total effective tax rate of 38.62%, up from the previous 28.97%. This nearly 10-percentage-point jump fundamentally changes the math for professional corporations and private holding companies, making tax-efficient withdrawal strategies and registered account contributions (like RRSPs and TFSAs) more critical than ever.

To Sell or to Hold: The Seven-Year Rule

With the new rules set to take effect on June 25th, 2024, many investors are asking if they should trigger gains now to lock in the 50% inclusion rate. If you were already planning to sell an asset in the immediate future, moving that sale up by a few days is a clear win. However, if you are a long-term investor, the decision is much more nuanced. Paying tax today, even at a lower rate, carries a heavy opportunity cost: you lose the ability to earn compounded returns on the money you sent to the Canada Revenue Agency.

Our modeling at PWL Capital suggests a 'break-even' point for this decision. For an individual in the top Ontario tax bracket holding a diversified equity portfolio, the benefit of deferring the tax bill usually outweighs the benefit of the lower rate if the holding period is longer than seven years. If you plan to hold the asset for a decade or more, the power of compounding on the deferred tax liability typically makes up for the higher rate you will eventually pay. Selling today just to save on the rate increase could actually leave you with less wealth in the long run.

Mitigating Tax-Rate Risk

This policy shift highlights a concept often overlooked by DIY investors: tax-rate risk. We spend a great deal of time managing market volatility and return uncertainty, but the stroke of a legislator’s pen can have just as much impact on your 'take-home' wealth. Managing this risk requires tax diversification—having money in multiple 'buckets' like corporations, RRSPs, and TFSAs that are treated differently by the tax code.

One strategy we employ to mitigate this risk is 'gain harvesting'—intentionally realizing gains in years when a client has lower income to use up lower tax brackets. This lowers the 'terminal' tax bill at the end of a life or the end of an investment horizon. In light of the 2024 budget, the value of low-turnover investments, such as index funds and ETFs, becomes even more apparent. Because these funds trade infrequently, they avoid triggering the annual capital gains distributions that actively managed funds often force upon their investors.

Beyond the Ticker Symbol

It has often been said that 'investing is solved.' Buying a low-cost, diversified portfolio is easier today than at any point in history. However, as these tax changes demonstrate, a portfolio is not a financial plan. A true plan must integrate investment decisions with estate planning, corporate tax integration, and long-term tax-bracket management. The literal action of buying an ETF is simple; the strategy of when and where to hold that asset is where the real value is found.

The proposed increase in the capital gains inclusion rate is a reminder that the environment in which we invest is constantly shifting. While the headline numbers may seem daunting, the fundamentals of sound wealth management remain the same: minimize unnecessary turnover, maximize the use of registered accounts, and don't let the 'tax tail' wag the 'investment dog' by selling high-quality assets prematurely.