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The Capital Inclusion Rate - What Could Happen and What Should You Do

Jared Burns, CPA, CA

November 6, 2021


Here are a few things to consider if the Liberal government increases the capital inclusion rate from 50% to 75%.


“Okay campers, rise, and shine, and don't forget your booties ‘cause it’s cold out there… it’s cold out there every day.” a line from Phil played by Bill Murray, a character in 'Groundhog Day', a terrific romantic comedy classic. It sums up how I feel every year lately, as financial advisors, accountants, tax folks alike speculate that the Liberal government will increase the capital inclusion rate from 50% to 75%.


The inclusion rate is the percent or part of a gain or loss from a capital (emphasis on capital) disposition that is subject to tax. There have been various inclusion rates since 1972 when the taxation of capital started. The inclusion rate has been at 50% since October 18, 2000.


Why this year feels different.


The inclusion rate is and always will be on the table come budget. I think, unlike prior years, we must consider a ballooning deficit. Pandemic programs are expensive. A capital gains inclusion rate increase to 75% would bring in little less than 10 billion a year for the next five (5) years, according to estimates released by the Parliamentary Budget Office. Also, Liberals hold a minority government, and although they didn’t have the increase of the capital inclusion rate in this past election campaign platform, the NDP’s did. Liberals may need political goodwill from the NDP’s, and the inclusion rate bump could be what’s offered. Lastly, it’s politically appetizing, it runs well with the sentiment of taxing the rich.


What can you do?


As an investor who has non sheltered investments that are exposed to the potential increase of the inclusion rate, here are three (3) things you could consider doing.


First, you could sell and buy back your winners at the 50% rate before the rate climbs to 75%. This would bump up your cost base of the investment and therefore reduce the amount of gain exposed to the higher 75% rate going forward.


Second, and essentially the other side of the same coin. You could hang on to your investments that are in a loss position and wait to sell them if the rate gets to the 75% inclusion amount. This makes your capital loss’ worth 25% more to you than if sold at the 50% inclusion rate. You can apply your capital losses against capital gains going back 3 years and forward indefinitely (carrying back in this case would require an adjustment as the inclusion rates in the two years would differ).

The third action is for those who hold their investments corporately. We will not get into the details in this article, but it involves a transfer, using a “tax deferred rollover” provision, of your appreciated securities to a holding company. You then use the delay inherent in the required election form for the rollover on when it needs to be filed. It hinges on the fact that you time it, so the form is due after you know if the inclusion rate has changed. Then you decide what amount to elect at. This is a strategy you should talk to your accountant, tax expert or advisor about.


What should you do?


There are other strategies you could employ. But should you? I would caution any investor who wants to initiate any investment decision based on tax alone like in the above. This holds especially true if you’re in investing for the long haul.


Say you decide to follow the first item above and trigger your gains now at 50% for an increased cost base of your investments. Running the numbers, you would notice that there’s a crossover point where deferring the payment of any tax by not triggering a gain will put you better off than selling today, paying some tax, and using the net proceeds to reinvest and establish the new higher cost base. For example, at a 7% linear/annualized growth rate, no dividend, both scenarios at NB’s top marginal rate throughout, it would take about 9 years where holding on and deferring any taxes starts to be better. Not very long if you’re investing for retirement. This timeline shortens if either your rate of return increase and/or your tax rate throughout is lower. Not to mention, this does not even consider the transaction costs that would apply, the possibility that your tax rate in the future could change to a lower rate etc.


For the second strategy, holding on to a loss for any other reason than an investment decision is further going to fuel what we call “loss aversion” (the propensity to prefer avoiding losses to acquiring equivalent gains). Basically, following the second piece of advice above blindly might mean you hang on to “losers” longer than you should


All this is to say, you should not make your investment decisions because of possible tax changes alone. Taxes should be considered as a factor in the holistic analysis by your portfolio management firm. It should, however, very rarely dictate a decision on its own basis.


That doesn’t mean it wouldn’t be a good idea or time to look at your risk profile with your advisor and determine whether you should rebalance your portfolio. A rebalance will require the selling of some equity that may be at a gain, which would be wise to do before the possible rate increase.


Author:

Jared Burns CPA, CA is the Director of Estate and Tax Planning with Louisbourg Investments. Submit your comments to jared.burns@louisbourg.net.





Read more articles from Jared:

Shareholder Agreement – what is it and why it matters

New Tax Rules for Employee Stock Options (ESOs)


This writing is for general information purposes only. It is not intended to provide legal, accounting, tax or financial advice. For complex matter you should always seek help from a professional. Any opinions expressed are my own and may not reflect those of Louisbourg Investments.

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