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Lyndon Braun

Partner at Manning Elliott Vancouver
by Lyndon Braun
December 22, 2021

Choosing When to Defer Capital Gains Tax

When would be the best time to defer capital gains tax? Anyone who tells you they know with any certainty where Canada’s tax policy is going to go in the future, is pulling your leg. As tax advisors, many of us spend our time speculating on possible changes and shifts in tax law that will affect our clients.

Economic Changes & Shifting Tax Rates
Most recently there has been an undercurrent of negative expectations permeating through the tax planning community. Whether it is related to the large-scale government fiscal deficits, incredible housing market booms, or other economic trends like inflation, economic changes are happening all around us. It would seem that the pervasive sentiment in the tax planning community, with regards to the economic turmoil, is that tax rates have only one way to go, and that is UP. 

While no one has a crystal ball to see what happens next, we are regularly having discussions with our clients and their financial advisors trying to lay out plans on navigating these issues.

How Long Can You Defer Capital Gains Tax?
Importantly, the rule of thumb in tax planning has historically been to defer the realization of taxable income and taxable gains wherever possible.
The rationale for this is in that the deferral of taxes is really a preservation of capital and an increase in return on that capital – because more of it is left to compound each year. But if you follow the rationale that perhaps tax rates are going up, does the attractiveness of tax deferral stay the same?

For some context, historically in Canada capital gains tax rates have been incentivized as a matter of public policy. Capital gains realized by investors are currently subject to tax on only half of the gain. Whether realized corporately or personally, capital gains currently have an effective tax rate around 26% at the highest marginal rate (24.0% in Alberta, 26.75% in BC, and 26.76% in Ontario). Any way you slice it, there are significant tax rate advantages of a capital gain over almost any other type of income, whether its wages, rents, interest, or dividends.

A Brief History of the Capital Gains Tax in Canada

  • January 1, 2022, is the 50th anniversary of the capital gains tax
  • 1972 – it started with a 50% Inclusion Rate and all prior capital gains were exempted 
  • 1988 – the Inclusion Rate was increased from 50% to 66.67% 
  • 1990 – the Inclusion Rate was increased again to 75%
  • 2000 – the Inclusion Rate was reduced back to 50% and has remained there since

 

Will Capital Gains Tax Rates Increase?
So, what would happen if the prevailing public policy to incentivize investment and resulting capital gains suddenly switches? There has been speculation that the capital gains rate could be increased by altering “Inclusion Rate,” or the formula that currently makes only half of the gain taxable. If the Inclusion Rate for capital gains was increased from 50% to say, 75%, it would result in taxes on a capital gain being effectively increased from 26% to almost 40%. 

Impact on Sale of Assets
The impact would be monumental with regards to latent tax built into the future sale of investments and assets. The implementation of any change is also a source of uncertainty at this point: would new rules apply as of the date of announcement or retroactively to the beginning of the tax year?

In the current environment one thing that is certain is that the rule of thumb about when to defer capital gains tax should no longer be blindly followed. Instead, a contextualized discussion should be taking place that considers:
•    Tax rates
•    Opportunity costs
•    Liquidity and available cash flow
•    As well as time frames for the eventual sale of assets
Each person will have a different context and a different timeframe, and there is not a one size fits all solution.

Triggering Gains – Example
As an example, if you are thinking of selling an investment in two to three years, does it make sense to trigger the taxes on that eventual gain now, at the prevailing rates that exist today? From the perspective of risk management and return on investment, the shorter the time frame to actual sale, the better the outcome on locking in the tax rates today if those tax rates do increase in the future. 

Summary
The use of capital and how possible changes in tax rates would affect your financial health is a very material and timely topic and could have a significant impact to your finances. By thinking ahead, you can become better informed but more importantly, you will be empowered to decide how to manage these uncertainties and minimize the risk that rate changes may carry for you and your financial health.

We Are Here to Help
Manning Elliott is here for you. If you still have questions about rising tax rates or when to defer capital gains tax, please reach out to our tax experts or contact the author Lyndon Braun, CPA, CA.

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