Wealthy Canadians spent big to plan around capital gains tax changes that never happened

Open this photo in gallery:

Some wealthy Canadians spent tens of thousands of dollars last year on sophisticated tax planning to get ahead of Ottawa’s proposed hike to the capital gains inclusion rate, only to see the federal government abandon the measure earlier this year.

Clients who wanted to lock in the lower inclusion rate before June 25, 2024 – the original effective date for the proposals – undertook “crystallization” transactions using provisions in the Income Tax Act (ITA) that provided them with the option of electing out of the gain later.

Now that the proposed capital gains changes aren’t proceeding, Canadians who acted find themselves no better off from a tax perspective than those who did nothing.

“In June [2024], when everyone was doing this planning, nobody knew that we’d get to a point at which the government never actually followed through with the legislation,” says Armando Minicucci, partner with Doane Grant Thornton LLP in Mississauga.

“Clients are now stuck with these structures they put in place, and there’s [an additional] cost associated with unwinding them.”

Those structures include transfers of property to a corporation in exchange for shares and transfers to a partnership in exchange for an interest in the partnership.

Mr. Minicucci estimates taxpayers paid fees between $20,000 and $70,000 on legal, tax and accounting advice and services related to crystallization transactions completed before June 25.

Michael Cadesky, managing partner with Cadesky Tax in Toronto, says professional advisory costs related to pre-June 25 planning could run as high as $100,000 for taxpayers with “sophisticated structures” who may have used crystallization transactions as part of broader planning.

“For a lot of people, it was an expensive proposition,” Mr. Cadesky says.

Crystallizing capital gains

In the 2024 federal budget, the Liberal government proposed increasing the capital gains inclusion rate to two-thirds for corporations and trusts as well as for individuals with capital gains above an annual threshold of $250,000. The hike in the inclusion rate was to be effective June 25, 2024, giving taxpayers 10 weeks to trigger gains and still have access to the lower rate.

Many taxpayers, such as those who owned vacation property, sold assets outright before June 25 to trigger capital gains to ensure access to the 50 per cent inclusion rate.

However, some individuals with assets of significant value, such as shares of a small business, undertook transactions that allowed them to transfer property as of a certain date and retain flexibility to elect out of triggering a gain later.

Here’s an example of how such a transaction works:

• An incorporated taxpayer transfers eligible property before June 25 from an investment corporation to a holding corporation in exchange for shares. The taxpayer controls both corporations.
• After June 25, and relying on subsection 85(1) of the ITA, the corporations file a joint election to have the transfer completed either at the property’s adjusted cost base (ACB) or its fair market value (FMV) at the time of the transfer (or at any amount in between the ACB and FMV).
• If an election is made to transfer the property at the ACB, there’s a “rollover” of property, meaning tax is deferred until the holding corporation sells the asset in the future.
• If an election is made to transfer the property at the FMV, the investment corporation realizes the capital gain as of the date of the transfer.
• The corporations must file the joint election by the tax return filing deadline (for whichever corporation’s deadline is earlier).

Now that the capital gains tax changes have been cancelled, many clients will elect to have pre-June 25 crystallization transactions completed at ACB to defer taxes, experts say.

Alexandra Spinner, a partner with Crowe Soberman LLP in Toronto, says clients who had plans to sell a property soon – or were already in the process of selling but didn’t anticipate closing a deal before June 25 – used crystallization transactions to lock in access to the lower inclusion rate while giving themselves more time to find a buyer or close a deal.

Costs to put such planning in place generally start at $10,000, “and then only climb higher,” Ms. Spinner says. “It depends on how complex the assets are.”

The use of crystallization transactions, particularly as part of tax planning when selling a business, isn’t unusual, she adds.

The Canada Revenue Agency (CRA) was aware that taxpayers were using crystallization transactions to get ahead of the proposed changes last year, and even gave the transactions their blessing.

On April 29, 2024, the CRA released guidance indicating that “where a taxpayer crystallizes an accrued capital gain prior to the increase in the capital gains inclusion rate, the [general anti-avoidance rule] would generally not apply to redetermine the inclusion rate.”

Spousal transfers

Some taxpayers used strategies other than transfers to corporations and partnerships to plan around the proposed capital gains tax changes last year.

For example, some taxpayers transferred an asset to a spouse before June 25. Transfers to a spouse are automatic rollovers of property unless the transferor elects out of the rollover on their tax return to have the transfer completed on a taxable basis, triggering a capital gain.