Peter Power/The Globe and Mail
There's been much talk about the possibility that the Liberal government will increase the capital gains inclusion rate in the federal budget to be tabled March 22. Currently, just 50 per cent of capital gains are taxable, but some believe the rate could increase to 66.67 per cent or 75 per cent. (The latest indications are that the more significant tax changes by the Liberals will come at a later date.) There are a host of reasons why increasing the rate would be a bad move for the middle class (a topic for another time).
It raises the question: Should you sell an asset with an accrued capital gain before the federal budget, to take advantage of today's 50-per-cent inclusion rate? Perhaps. Particularly if the asset is something you're thinking of selling in the near future anyway. While selling before the budget should allow you to take advantage of today's inclusion rate, you could end up paying tax unnecessarily if you sell today and the rate doesn't increase.
There's an idea to consider. It may be possible to sell an asset before the federal budget, to take advantage of today's lower rates on capital gains if the rate does increase in the budget, but won't penalize you with an unnecessary tax bill if it turns out the tax rate on capital gains doesn't change and you wished you hadn't sold the asset.
The idea
Consider spouses Jack and Jill. Jack owns shares of XYZ Corp. that are worth $200,000, with a cost amount – an adjusted cost base (ACB) – of $100,000. So, the shares have appreciated in value by $100,000. Jack is concerned about a possible increase to the capital gains inclusion rate in the coming federal budget. If that rate jumps to, say, 75 per cent, then he'll pay about an extra $12,500 (or 12.5 per cent) on that gain than he'd pay at today's inclusion rate (he's in the highest tax bracket).
Jack has decided to transfer his XYZ shares to Jill before the budget. He's going to take back, in exchange, a signed promissory note from Jill for $200,000 on the date of the transfer. He'll charge the current prescribed rate – just 1 per cent – on that note.
What happens from a tax perspective? Any transfer from one spouse to another is deemed to take place at your ACB, and so no tax is triggered. This is true even if your spouse pays you fair market value for the assets, unless you also elect on your tax return for the transfer to take place at fair market value rather than your cost.
Back to Jack. If the federal budget does not increase the capital gains inclusion rate, he would rather avoid the capital gain on the transfer of his XYZ shares to Jill, since he'd be paying tax sooner than necessary. In that case, he will not make the fair market value election on his tax return that he files for 2017, so that his transfer to Jill will take place at his ACB. On the other hand, if the inclusion rate does increase in the budget, he'll make the election on his tax return for 2017 and treat the transfer to Jill as a fair market value transaction, triggering tax, but taking advantage of the lower inclusion rate in effect on the date of the transfer.
The nuances
Some final thoughts: If the inclusion rate is increased in the budget and made retroactive to some earlier date, say, Jan. 1, 2017 (which is not likely given that all changes like this in the past have been effective on the budget date and not retroactive – which is fair), then making a transfer before the budget date may not allow Jack to take advantage of the current inclusion rate.
If Jack chooses for the transfer to Jill to take place at his ACB by not making the fair market value election, then the attribution rules will apply, and any income or capital gains on the XYZ shares later will be taxed in his hands – not Jill's.
This spousal transfer idea can apply to a transfer of any asset, not just portfolio securities as in my example, but be sure to count all the costs that might apply on a transfer of assets (commissions, other fees, etc.).
Finally, some might be concerned about the general anti-avoidance rule (GAAR) that might apply here. GAAR simply should not apply. If you take advantage of today's lower inclusion rate after an increase to the rate on budget day, you will have properly documented the transfer prior to budget day and are entitled to make the fair market value election in the spring of 2018 when you file your 2017 tax return (our tax law does not require you to make the election at the time of the transfer).
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author and founder of WaterStreet Family Offices.
Tim Cestnick