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Small Business and the Federal Budget, 2024

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Intentional Wealth Insights with Jim Pelot

As you may know by now, the Federal government changed the rules of the game fairly substantially for small business owners last week when they tabled their budget. The most significant change was of course the increase in the “Capital Gains Inclusion Rate”.
NOTE 1: While the commentary provided in conjunction with the budget suggested that these changes would only affect a very small minority of “wealthy” Canadians, they will in fact be important and relevant to anyone operating a small business in Canada, that is to say the 1.3 million small businesses employing approximately 2/3 of all Canadians.

NOTE 2: this review should not be considered or relied upon as tax advice and represents the views and opinions of Podium Prosperity Group

Four important parts to the changes:

1. The Capital Gains Inclusion Rate is increasing from 50% to 66.67%. The inclusion rate specifies how much of a capital gain is taxable. Generally speaking, capital is taxed much more lightly than labour. This difference in taxation is what afforded and created the vast wealth pools that established the modern economy.

The inclusion rate has varied over the last several decades. Between 1988 and 1990  it was 66.67% and from 1990 to 2000, 75%.

From June 25, 2024 forward, 2/3rds of capital gains will be taxable at the relevant rate for both individuals and corporations.

There is, therefore, a small window to “trigger” a capital gain before the rates increase, but that will mean paying tax earlier than you otherwise would have. We have calculated that as a (very broad) rule of thumb, this would only make sense if the capital gain was otherwise going to be realized within the next 3 or so years.

It does not appear that there will be the opportunity to “freeze” existing gains that are not realized (so that only increases in value after June 25, 2024 would be taxed at the higher rate). This transitional relief was a feature of previous capital gains inclusion rate increases.

How this matters to small businesses: The increase in capital gains tax will disfavour owners who exit their businesses by selling their assets versus selling their shares (see below on LCGE and other changes)

2. Relief will be provided for individuals. A cornerstone policy aspect of Canadian tax is that taxpayers should be indifferent as to whether or not they are incorporated. This “integration” intent is most clearly shown in the overall tax equivalency of taking a salary or dividends as a business owner, an analysis we review with all of our clients.

Unusually, the government decided to retain the 50% inclusion rate for individuals on the first $250,000 of capital gains (not corporations). The difference breaches the integration principle, and favours earning capital gains (at least to some extent) outside of corporations. Those who are familiar with the government’s extraordinary tax on Corporately Earned investment income introduced in 2017 will be able to see a continuation of the tax squeeze on small business Retained Earnings in this move.

How this matters to small businesses: In general, we do not believe that the spread created will materially affect portfolio management of retained earnings, but each business owner’s situation is unique and should be analyzed and considered.

3. The Lifetime Capital Gains Exemption is being bumped up. The LCGE, whereby properly structured corporations and transactions allow qualifying shareholders to exclude a significant amount of capital gains on sale of their business has received a one-time bump to $1,250,000 from $1,016,000 for 2024, before resuming its inflation adjusted increase next year from the new increased baseline. This is great news for business owners who are building saleable businesses.

How this matters to small businesses: It should be the goal of every small business owner to sell the shares of their company, rather than the assets. While this is not always possible, the increase in the LCGE makes it even more beneficial relative to selling assets (see point 1. Above).

4. A new capital gains shelter is being introduced for entrepreneurs the “Canadian Entrepreneurs’ Incentive”. This addition to the LCGE starts at $200,000 for qualifying businesses and owners and is intended to grow to $2,000,000 by 2034. There are a number of conditions (owning at least 10% of the shares and having worked principally in the business for 5 years) and a number of excluded business types such as financial, insurance, real estate, food and accommodation, arts, recreation and entertainment, along with consulting or personal care services. The government was not forthcoming on the rational for its exclusions and conditions.

How this matters to small businesses: For those who will qualify, the additional LCGE could prove to be a very meaningful reduction in taxes otherwise payable, especially if an exit is not planned for the next several years while the shelter grows at $200,000 per year. Note that this shelter further increases the advantage of selling the shares rather than the assets of the business in ways that those unable to do the former will find extremely taxing.

In summary, the core structural planning of the last several decades of family trusts and holding companies remains attractive and viable. (Warning: don’t try this at home. At least once a month we meet a client who set this structure up wrong – backward, sideways, inside out – and the cost of unwinding and fixing the wrong corporate structure is in the tens of thousands, not even counting the tax leakage.)
Consideration as to the location and/or earnings of future capital gains will need to be considered in an holistic portfolio sense for each family business and structure.

If the above sounds uncertain to some extent, it’s because the government did not introduce any legislation to go along with the new “laws” that are being implemented. Even though they are coming into effect June 25 of this year… there is a lot of uncertainty as to how any of these changes are going to be implemented.

There were, of course, many other provisions to the budget; our goals here was to highlight those that impacted small business owners particularly.

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