NEW Capital Gains Inclusion Rate

From: Department of Finance Canada

Backgrounder

One half of a capital gain is currently included in computing a taxpayer's income. This is referred to as the capital gains inclusion rate. The current one-half inclusion rate also applies to capital losses.

Budget 2024 announced an increase in the capital gains inclusion rate from one half to two thirds for corporations and trusts, and from one half to two thirds on the portion of capital gains realized in the year that exceed $250,000 for individuals, for capital gains realized on or after June 25, 2024.

Today, the government is reaffirming its intention to make the tax system fairer by tabling a Notice of Ways and Means Motion to introduce legislation to implement the measure as proposed in Budget 2024. The Department of Finance is also releasing this backgrounder to explain the key design details for this measure.

The information contained in the backgrounder, along with the details already provided in the Budget documents, covers all the main features of the proposed changes to the capital gains inclusion rate. Further technical changes will be released later, but these changes will not materially affect the design of or introduce new features to the measure.

Updated draft legislation that adds these further technical changes to the legislative proposals in today's Notice of Ways and Means Motion will be made available at the end of July 2024.

Basic Inclusion Rate and $250,000 Threshold for Individuals

The basic inclusion rate for all capital gains and losses would increase from one half to two thirds as of June 25, 2024.

Individuals (except for most types of trusts) would have access to a reduction when calculating their total income that would effectively decrease the inclusion rate applied to their capital gains under the $250,000 threshold from the basic inclusion rate of two thirds to one half. This reduction would be available on capital gains realized directly by these taxpayers in the year, including amounts brought into income from a capital gains reserve or allocated by a partnership or trust, and would be determined net of any capital losses for the current year. If there is a capital gain on a disposition of a property jointly owned by multiple individuals, each individual would have access to their $250,000 threshold.

Deductions for net capital losses, the Lifetime Capital Gains Exemption (LCGE), the proposed Employee Ownership Trust Tax Exemption, and the proposed Canadian Entrepreneurs' Incentive are based on taxable capital gains, after the inclusion rate is applied. The amount of such a deduction would effectively be reduced to the extent that it offsets a taxable capital gain that was effectively included at a one-half inclusion rate. As a result, these deductions would be available consistently in respect of capital gains regardless of the applicable inclusion rate.

Graduated Rate Estates and Qualified Disability Trusts would also be eligible for the $250,000 threshold available to individuals in respect of capital gains that are not allocated to a beneficiary in the year, reflecting that these trusts are subject to the same progressive personal income tax rate structure.

Net Capital Losses

Net capital losses may be carried back three years and forward indefinitely to offset capital gains of other years.

Net capital losses of other years are deductible against current-year taxable capital gains by adjusting their value to reflect the inclusion rate of the capital gains being offset. This means that a capital loss realized when a different inclusion rate applied can still fully offset an equivalent capital gain realized in a year during which another inclusion rate applied.

For example, assume a taxpayer incurred a capital loss of $100 in 1998 (when the inclusion rate was three quarters); this would be recorded as a net capital loss of $75. Now assume that the taxpayer realized a capital gain of $100 in 2023 (when the inclusion rate was one half); this would result in a taxable capital gain of $50. If the taxpayer claimed the $75 net capital loss from 1998 as a deduction in computing taxable income in 2023, the taxpayer would be entitled to a deduction of only $50. This is because the net capital loss from 1998 is adjusted to reflect the inclusion rate applicable to the year in which the net capital loss is deducted – in this case, 2023. The result is that the capital loss of $100 from 1998 fully offsets the capital gain of $100 from 2023.

These adjustments would continue to apply on or after June 25, 2024, but additional adjustments would be required when capital gains have been subjected to an effective inclusion rate of one half rather than the basic inclusion rate of two thirds. Generally, a taxpayer can determine the value of a net capital loss from another year relative to the tax return year by multiplying the value by the appropriate adjustment factor in Table 1 below.

Table 1
Adjustment Factors for Applying Net Capital Losses of Other Years

Inclusion Rate at Time of Capital Loss

Inclusion Rate of Offsetting Capital Gain in Tax Return Year

One-Half

Two-Thirds

One-Half

4/3

Two-Thirds

3/4

Three-Quarters

2/3

8/9

Example 1

Assume an individual has the following circumstances in the 2025 tax year.

Realizes a capital gain of $450,000.
Realizes a capital loss of $50,000.
Has a net capital loss of $150,000 from 2017 (capital loss of $300,000).

They have a net capital gain of $400,000 for the 2025 tax year. The first $250,000 would effectively be included at a one-half inclusion rate (taxable capital gain of $125,000). The remaining $150,000 would be included at the basic two-thirds inclusion rate (taxable capital gain of $100,000). These taxable capital gains would therefore increase their total income by $225,000.

When calculating taxable income, they would be allowed to deduct $175,000 in respect of the net capital loss from 2017. This represents a deduction of $100,000 in respect of the portion of the net capital loss that offsets the portion of the taxable capital gain included in income at two-thirds ($75,000 × adjustment factor 4/3), and a deduction of $75,000 in respect of the portion of the net capital loss that offsets the portion of the taxable capital gain effectively included in income at one-half ($75,000 x adjustment factor 1).

This effectively results in $50,000 ($225,000 - $175,000) of taxable capital gain remaining to be included in taxable income. The result is as if the remaining $100,000 capital gain ($450,000 capital gain less the $50,000 current-year and $300,000 prior-year capital losses) was included in income at the lower one-half inclusion rate. Put differently, net capital losses are effectively applied first to offset capital gains subject to the higher inclusion rate.

Transition Year

For tax years that begin before and end on or after June 25, 2024, two different basic inclusion rates would apply. As a result, taxpayers would be required to separately identify capital gains and losses realized before June 25, 2024 (Period 1) and those realized on or after June 25, 2024 (Period 2). Gains and losses from the same period would first be netted against each other. A net gain (loss) would arise if gains (losses) from one period exceed losses (gains) from that same period. Taxpayers would be subject to the higher inclusion rate in respect of their net gains arising in Period 2 (excluding the portion that does not exceed the $250,000 threshold in the case of individuals), to the extent that these net gains are not offset by a net loss incurred in Period 1.

The annual $250,000 threshold for individuals would be fully available in 2024 (i.e., it would not be prorated) and would apply only in respect of net capital gains realized in Period 2 less any net capital loss from Period 1.

Example 2

Robert realizes a capital gain of $600,000 on June 1, 2024, a capital loss of $75,000 on July 25, 2024, and a capital gain of $475,000 on October 1, 2024.

Robert has a capital gain of $600,000 in Period 1 on which the one-half inclusion rate would apply, resulting in taxable capital gain of $300,000.
Robert has a net capital gain of $400,000 in Period 2. A one-half inclusion rate would effectively apply to the first $250,000, and a two-thirds inclusion rate would apply to the remaining $150,000, resulting in a taxable capital gain of $225,000 in Period 2.
The total taxable capital gain for the 2024 tax year would be $525,000.

Employee Stock Option Deduction

When an employee exercises a stock option, the difference between the fair market value of the stock at exercise and the amount paid for the stock, known as the employee stock option benefit, is included in the employee's income. Historically, this benefit has been treated as similar to a capital gain, with one half of the benefit deductible from income (provided certain conditions are met). Where the stock option is in respect of a share of a Canadian-controlled private corporation (CCPC), the inclusion of the stock option benefit is normally deferred until the taxation year in which the employee disposes of or exchanges the share.

As a result of the proposed changes to the inclusion rate, claimants of the employee stock option deduction would be provided with a basic one-third deduction of the taxable benefit for stock options exercised on or after June 25, 2024, or, in the case of a CCPC share, where the share is disposed of or exchanged on or after June 25, 2024. This reflects the new basic inclusion rate of two thirds. This deduction could be increased to one half on up to a combined annual limit of $250,000 for both employee stock option benefits and capital gains. This approach would preserve the longstanding treatment of employee stock option benefits as generally equivalent to capital gains.

When the total employee stock option benefits and capital gains exceed $250,000, the allocation of the preferential treatment would be at the taxpayer's discretion.

Example 3

Assume the following facts apply to Lindsay during the 2027 tax year.

Realizes a capital gain of $125,000.
Has employee stock option benefits of $200,000.

Lindsay can elect to receive a one-half deduction on the full amount of the $200,000 employee stock option benefits (i.e., $100,000) when calculating her taxable income.

As a result of this election, $50,000 of the capital gain would effectively be included at a one-half inclusion rate and the remaining $75,000 would be included at a two-thirds inclusion rate, for a total taxable capital gain of $75,000 ($50,000 × ½ + $75,000 × ⅔).

Alternatively, Lindsay can elect to have the one-half inclusion rate apply to the full amount of the capital gain, resulting in a taxable capital gain of $62,500 ($125,000 x ½). She can receive a one-half deduction on $125,000 of her stock option benefit and one-third on the remaining $75,000, for a total deduction from taxable income of $87,500 ($125,000 x ½ + $75,000 x ⅓).

Lifetime Capital Gains Exemption

The income tax system currently provides a lifetime capital gains exemption (LCGE) on up to $1,016,836 of capital gains realized on the disposition of qualified farm and fishing property or qualified small business corporation shares. This lifetime limit is increased every year based on an inflation indexation factor.

Budget 2024 proposed to increase the LCGE limit to $1.25 million of eligible capital gains. This measure would apply to dispositions that occur on or after June 25, 2024. Indexation of the LCGE would resume in 2026.

In practice, the lifetime capital gains exemption is provided in the form of a deduction when calculating an individual's taxable income. As of January 1, 2024, the maximum lifetime deduction is $508,418 (i.e., $1,016,836 x the current ½ inclusion rate). Starting on June 25, 2024, the new maximum lifetime deduction would be $833,333 ($1,250,000 × ⅔) to reflect the new basic inclusion rate of two-thirds and the increased lifetime limit of $1.25 million.

If an individual claims the LCGE in respect of a capital gain realized on or after June 25, 2024 that was effectively included in income at the one half inclusion rate, the amount of the deduction would effectively be reduced to reflect the lower effective inclusion rate. This mechanism would allow for the exemption of $1.25 million in eligible gains regardless of the effective rate at which those gains would have otherwise been included in income.

For example, if a first-time LCGE claimant realizes a $1.25 million eligible gain in 2025 and has no other capital gains or employee stock options, the individual would include $791,667 ($250,000 × ½ + $1M × ⅔) in computing their income. To fully offset this income inclusion, the individual would in effect be permitted a net LCGE deduction of $791,667 in computing their taxable income, but this deduction would reduce their remaining LCGE limit by the full $833,333 to ensure they cannot exceed their lifetime limit.

Example 4

As of December 31, 2023, Max has claimed the LCGE in respect of $990,000 in capital gains over his lifetime. On April 1, 2024, he disposes of shares eligible for the LCGE, realizing a capital gain of $50,000. On August 1, 2024, he disposes of different shares eligible for the LCGE, realizing a capital gain of $100,000. He realizes no other capital gains or losses in 2024.

Max has a remaining LCGE limit of $26,836 at the beginning of 2024 ($1,016,836 - $990,000).
Max can claim the LCGE deduction in respect of $26,836 of the $50,000 capital gain realized on April 1. The remaining $23,164 would not qualify for the LCGE because he has exhausted his lifetime limit (remaining LCGE limit is now nil).
On June 25, 2024, Max's remaining LCGE limit increases to $233,164 ($1,250,000 - $1,016,836).
Max can claim the LCGE deduction in respect of the full $100,000 capital gain realized on August 1.
At the end of 2024, Max has a cumulative gains limit of $133,164 that can be carried forward.

Allowable Business Investment Losses

Capital losses arising from the disposition of shares and debt instruments are generally deductible only against capital gains. However, one half of the capital loss from a deemed disposition of bad debts or shares of a bankrupt small business corporation or from a disposition to an arm's length person of shares or debts of a small business corporation (known as an "allowable business investment loss") may be used to offset other income like income from business, property (interest and rent) and employment.

Unused allowable business investment losses may be carried back 3 years and forward 10 years and used to offset income from any source. After 10 years, the loss reverts to an ordinary net capital loss and may be carried forward indefinitely but only used to offset capital gains.

The deductible proportion of an allowable business investment loss would increase from one half to two thirds for losses realized on or after June 25, 2024. Unlike net capital losses carried over to other years, allowable business investment losses are not adjusted to account for the inclusion rate that applies in the year the loss is claimed. This approach would be preserved and, as such, allowable business investment losses realized on or after June 25, 2024 would always be determined in reference to the new basic inclusion rate of two thirds, even if carried back and applied in any of the three previous years.

The amount of an allowable investment loss can be reduced if the lifetime capital gains exemption has been claimed in prior years. Similar reductions would apply in respect of the proposed Employee Ownership Trust Tax Exemption and the partial exemption under the proposed Canadian Entrepreneurs' Incentive.

Example 5

Gervais realizes a $12,000 capital loss on the disposition of shares of a bankrupt small business corporation on September 1, 2024. He has no other capital gains or losses realized in 2024.

Gervais has an allowable business investment loss of $8,000 ($12,000 × ⅔).
Gervais could use this allowable business investment loss to offset up to $8,000 in non-capital income (e.g., employment income) received or accrued at any time in 2024, in the previous three years or in the next ten years before it would revert to an ordinary capital loss.

Capital Gains Reserves

In some cases, a taxpayer may receive portions of the payment from the sale of a capital property over a number of years. Under those circumstances, realization of a portion of the capital gain may be deferred until the year in which the proceeds are received.

If the proceeds are derived from the sale of a farm or fishing property or small business shares to a child, grandchild or great-grandchild, a minimum of 10 per cent of the gain must be brought into income per year, creating a maximum ten-year deferral period. Amendments in Bill C-59 would extend this ten-year deferral period to shares transferred as part of an intergenerational business transfer or sold to an employee ownership trust. For other capital property, a minimum of 20 per cent of the gain must be brought into income per year, creating a maximum 5-year deferral period.

When a capital gain is brought out of reserve in a subsequent year, it is included in income at the inclusion rate applicable for that subsequent year. For example, if a reserve is claimed in respect of a capital gain realized in 2023, any portion of the gain that is brought into income in 2025 would be included at the basic two-thirds inclusion rate (which could effectively be reduced, for example, to one half if under the $250,000 threshold for individuals).

For taxation years that include June 25, 2024, the amount of a capital gain that is brought out of reserve would be deemed to be a capital gain of the taxpayer from a disposition of property on the first day of the taxpayer's taxation year for the purpose of determining the inclusion rate. For example, if a taxpayer has a taxation year that begins before June 25, 2024 and ends after June 24, 2024, any capital gain brought out of reserve in that taxation year would not be subject to the higher basic inclusion rate.

Example 6

On April 1, 2024, Mio closed a deal to sell a property to an arm's length corporation for $20 million. Under the terms of the deal, the buyer will pay $4 million on April 1, 2024, and will make four additional payments of $4 million on April 1 of 2025 through 2028. The capital gain arising on the sale is $10 million.

If Mio chooses to include the full amount of the capital gain in income in 2024, the entire $10 million capital gain would be included in income at a one-half inclusion rate, resulting in $5 million in taxable capital gains.
Otherwise, if Mio takes full advantage of the five-year reserve and includes only 20% of the capital gain in income each year, only the $2 million of capital gains would be realized in 2024 and would be included in income at a one-half inclusion rate, resulting in a taxable capital gain of $1 million.
For each of the 2025 through 2028 tax years, assuming Mio had no other capital gains or stock options, the first $250,000 of capital gains would be included in income at a one-half inclusion rate, and the remaining $1.75 million would be included at a two-thirds inclusion rate, resulting in annual taxable capital gains of $1,291,667.
Total taxable capital gains over five years would be $6,166,667.

Final Return and Net Capital Losses

If unapplied net capital losses remain after being applied to any taxable capital gains in the year of an individual's final return (i.e., their year of death), they may be applied to offset other income in the final taxation year and the immediately preceding taxation year.

The amount available is reduced by the amount of lifetime capital gains exemption deducted in the individual's lifetime. Similar reductions would apply in respect of the proposed Employee Ownership Trust exemption and the proposed partial exemption under the proposed Canadian Entrepreneurs' Incentive.

Net capital losses applied to non-capital income in the final or previous return of a taxpayer are determined based on the inclusion rate that applied in the year the capital loss is incurred and are not adjusted to account for the basic inclusion rate that applied in the year the non-capital income being offset was earned. This approach would continue as a result of the proposed change in the inclusion rate. For example, an allowable capital loss of $600 (arising from a capital loss of $900) originating on or after June 25, 2024 would be deductible against other income in the year of death and immediately preceding year, where eligible.

Example 7

A single senior passes away on October 13, 2026. Upon their death, they are deemed to have realized a $500,000 capital gain on their principal residence.

They did not realize any capital gains in 2026 or in any of the previous three years. They had a pension income of $60,000 in 2025 and $50,000 in 2026, and unapplied net capital losses of $75,000 from 2022 (capital loss of $150,000).

The full $500,000 capital gain would be exempted from tax under the principal residence exemption.
Since they had no taxable capital gains in the current and prior three tax years, the $75,000 net capital losses can be applied without adjustment to offset pension income from 2025 and 2026 (i.e., $37,500 in each year).

Capital Cost of Depreciable Property on Non-arm's length Transfer or Change in Use

Special rules apply in determining a transferee's capital cost of depreciable property that is acquired from a non-arm's length transferor or that is deemed to be acquired as a consequence of a change in use of the property from a non-income earning purpose to an income earning purpose.

In these circumstances, the transferee is generally deemed to have acquired the depreciable property at a capital cost equal to the transferor's capital cost plus one half of any capital gain the transferor realized on the disposition or deemed disposition of the property (other than any portion of the capital gain in respect of which the LCGE is claimed). Consequential on the proposed changes, this would be changed from one half to two thirds to reflect the increase in the capital gains inclusion rate.

However, if the transferor is an individual, the capital gain realized by the transferor on the disposition or deemed disposition of the depreciable property would be subject to an effective one-half inclusion rate to the extent that the transferor's net capital gains in the year did not exceed their $250,000 threshold amount.

To ensure that the tax treatment to the transferor and the transferee continue to align following the proposed changes, the capital gain realized by the transferor on the disposition or deemed disposition of the property would be subject to the basic two thirds inclusion rate except to the extent that an election is made to treat a portion of the capital gain as part of the transferor's net capital gains for the purpose of applying the $250,000 threshold.

If an election is made, the elected amount would be included in the transferor's net capital gains for the purpose of applying the $250,000 threshold. However, only one half of the elected amount would be added to the transferee's capital cost of the depreciable property.

The total amount of the transferor's net capital gains that can benefit from an effective one-half inclusion rate would continue to be limited by their $250,000 threshold for the year. As such, a transferor would not be expected to elect if they already had sufficient other capital gains in the year to receive the maximum benefit of the capital gains threshold.

Partnerships

In general, a partnership determines the income and loss from various sources for the fiscal period of the partnership as if the partnership was a separate person. The incomes and losses calculated at the partnership level are shared in the manner agreed to by the partners, subject to certain limitations. A partner's share of this income or loss is treated as the income or loss of the partner for the partner's taxation year in which the partnership's fiscal period ends.

When a partnership realizes a capital gain, capital loss or business investment loss from the disposition of capital property, the partnership computes the amount of the taxable capital gain, allowable capital loss or allowable business investment loss using the applicable capital gains inclusion rate in respect of the gain or loss for the fiscal period of the partnership. The appropriate share of each gain or loss is normally treated as a taxable capital gain, allowable capital loss or allowable business investment loss of each applicable partner for the partner's taxation year in which the partnership's fiscal period ends.

Special rules would apply where a taxpayer is a member of a partnership that has a fiscal period that begins before June 25, 2024 and ends after June 24, 2024. In this case, the amount of each taxable capital gain, allowable capital loss or allowable business investment loss that is shared with the taxpayer would be grossed up (doubled for gains in the pre-June 25 period or increased by 3/2 for gains in the post-June 24 period) and deemed to be a capital gain, capital loss or business investment loss of the taxpayer for the period (either pre-June 25, 2024 or post-June 24, 2024) in which the disposition of the relevant capital property occurred.

A partnership would be required to disclose to its partners in prescribed form which deemed capital gains, deemed capital losses, or deemed business investment losses allocated to the partners are attributable to dispositions of property in each period.

Each individual partner's $250,000 capital gains threshold would apply for the purpose of determining the effective inclusion rate of capital gains or taxable capital gains allocated to the individual as a partner of a partnership.

Trust Designations in Respect of Taxable Capital Gains

Typically, a trust resident in Canada can designate any part of its net taxable capital gains for a year (generally, its aggregate taxable capital gains less its allowable capital losses for the year) to one or more Canadian-resident beneficiaries of the trust at the end of the trust's taxation year. This allows the character of taxable capital gains to be preserved when flowed through the trust to its beneficiaries.

For the taxation year of a trust that begins before June 25, 2024 and ends after June 24, 2024, the amount designated in respect of its net taxable capital gains would instead be grossed up (doubled for gains in the pre-June 25 period or increased by 3/2 for gains in the post-June 24 period) and deemed to be capital gains realized by the beneficiary in the period that the trust disposed of the relevant capital property (either pre-June 25 or post-June 24). Trusts would be required to disclose to their beneficiaries in prescribed form the portion of the deemed capital gains that relate to dispositions of property that occurred in each period. If a trust does not disclose this information, the deemed capital gains would be deemed to have been realized after June 24, 2024.

Commercial trusts (i.e., trusts that are not personal trusts, such as mutual fund trusts) would have the option of electing the deemed capital gains allocated to investors to have been realized by them proportionally within the two periods based on the number of days in each period divided by the number of days in the trust's taxation year.

Mutual Fund Corporations, Mutual Fund Trusts and Mortgage Investment Corporations

The Act includes special rules for mutual fund trusts and mutual fund corporations that facilitate conduit treatment for investors (i.e., unitholders of the trust or shareholders of the corporation). These rules generally allow capital gains realized by a mutual fund trust or corporation to be treated as a taxable capital gain, or capital gain, respectively, realized by its investors. Mutual fund trusts rely on a trust designation to allow their beneficiaries to retain the character of a taxable capital gain. Mutual fund corporations may elect, subject to certain limitations, to treat a dividend payable to its shareholders as a capital gains dividend. This dividend is deemed to be a capital gain realized by the shareholder.

Furthermore, a capital gains refund mechanism is available to mutual fund corporations and mutual fund trusts. The intention of this refund mechanism is to eliminate the double taxation on capital gains that are flowed through to the shareholders and unitholders.

For taxation years of shareholders of mutual fund corporations that end on or after June 25, 2024, the tax treatment to the shareholder of the capital gains dividend would be based on when the corporation realized the underlying capital gain (either pre-June 25 or post-June 24). The corporation will be required to disclose to their shareholders in prescribed form the portion of the capital gains dividend that relates to dispositions of property that occurred after June 24, 2024 and, if the corporation does not do so, the capital gains of the shareholder receiving the dividend would be deemed to have been realized after June 24, 2024.

For taxation years that begin before June 25, 2024 and end after June 24, 2024, mutual fund corporations would also have the option of electing, for the purposes of the capital gains dividend distributed to its shareholders, that the underlying capital gain realized by the corporation be deemed to be realized proportionally within the two periods based on the number of days in each period divided by the number of days in that taxation year.

The tax treatment of mutual fund trust designations in respect of capital gains is described in the section above.

As a consequence of the change to the two-thirds inclusion rate, further adjustments would be made to certain values used in the computation of the capital gain refund mechanism for taxation years that end after June 24, 2024.

The tax treatment of mortgage investment corporations, and of shareholders receiving capital gains dividends from mortgage investment corporations, would be similar to that of mutual fund corporations.

Related Segregated Fund Trusts

Similar rules as those that apply to commercial trusts would apply to capital gains or capital losses deemed to be realized by a policyholder on a disposition of a property by a related segregated fund trust. Specifically, the related segregated fund trust would be required to disclose the deemed capital gains that relate to dispositions of property that occurred in each period but would have the option to make the proportional election that is also available to commercial trusts.

Foreign Affiliates and Hybrid Surplus

A foreign affiliate of a taxpayer resident in Canada is generally deemed to be resident in Canada for the purpose of determining amounts that are included in its foreign accrual property income. Accordingly, the change to the capital gains inclusion rate would apply for the purpose of computing the foreign accrual property income of foreign affiliates, in respect of capital gains and losses on dispositions of certain property (most commonly, property that is not "excluded property").

Various rules applicable in relation to foreign affiliates would also be amended, as necessary, consequential on the proposed change to the capital gains inclusion rate.

Notably, amendments would be made to the deduction available to corporations resident in Canada in respect of dividends received out of a foreign affiliate's hybrid surplus.

The hybrid surplus of a foreign affiliate of a taxpayer resident in Canada reflects capital gains and losses in respect of dispositions of shares of other foreign affiliates and partnership interests, as well as certain financial instruments relating to such shares and partnership interests, that qualify as excluded property of the foreign affiliate.

Under the current rules, where a corporation resident in Canada receives a dividend from a foreign affiliate that is prescribed to be paid out of hybrid surplus, the corporation is entitled to a deduction from taxable income equal to one half of the amount of the dividend (as well as a deduction in respect of applicable foreign taxes). This provides similar tax treatment to capital gains.

Dividends received by a corporation resident in Canada out of a foreign affiliate's hybrid surplus, relating to capital gains and losses in respect of dispositions occurring before June 25, 2024, would continue to be eligible for the one-half deduction when received on or after June 25, 2024. In the case of dividends received out of hybrid surplus relating to capital gains and losses in respect of dispositions occurring on or after June 25, 2024, the corporation would instead be entitled to a deduction equal to one third of the amount of the dividend (as well as a deduction in respect of applicable foreign taxes).

Taxpayers would be required to track hybrid surplus relating to capital gains and losses in respect of dispositions by their foreign affiliates occurring before June 25, 2024 (Period 1) separately from hybrid surplus relating to capital gains and losses in respect of dispositions occurring on or after June 25, 2024 (Period 2).

Various other rules relating to hybrid surplus would be amended in a manner consistent with the changes described above.

Non-Resident Dispositions of Taxable Canadian Property

Non-residents of Canada are generally subject to Canadian tax on capital gains from dispositions of taxable Canadian property (which includes real or immovable property, including Canadian resource property and timber resource property, and certain shares that derive their value from such property). To ensure collection, certain procedures apply. A non-resident person may obtain a certificate of compliance in respect of a disposition, or proposed disposition, of taxable Canadian property if the required tax on the capital gain is paid. Absent this certificate, the purchaser is required to withhold a portion of the proceeds as tax on behalf of the non-resident person.

The rate applicable to this withholding is intended to approximate the combined federal and provincial tax payable on capital gains at the highest marginal tax rates. Consequential on the proposed change to the capital gains inclusion rate, and to reflect current federal, provincial, and territorial tax rates, the withholding rate applicable to non-resident dispositions of taxable Canadian property would be raised from 25 per cent to 35 per cent, applicable to dispositions that occur on or after January 1, 2025.

Jane ZhaoOctober 6, 2024