'Let's be real, I think we're going to have increased taxes'

Why stakes are high for high earners ahead of federal budget

'Let's be real, I think we're going to have increased taxes'

Wealthy clients are braced for a hike in taxes in Tuesday’s federal budget and an increase to the capital gains inclusion rate of 50% may finally come to pass.

That’s the view of Anthony Gordon, co-founder and CEO of Fidusure Financial, who says increasing the capital gains rate has long been a possibility. Depending on how it’s done, it could mean that someone who reaches a certain income threshold would have to pay a higher amount.

“It’s been touted year after year, but let’s be real. I think we’re going to have increased taxes, and it may just show up here,” Gordon (pictured above, left) says. “For my clients with non-registered accounts, that’s going to be a potential challenge.” 

Finance Minister Chrystia Freeland said the government will offer targeted measures to help Canadians struggling against a double whammy of rising interest rates and inflation, but warned of a need to “exercise fiscal restraint.” She also underscored “significant and necessary investments” in health care and building Canada’s clean economy.

The government’s pre-budget report offered clues on what’s to come – and for high-income earners and business owners, it might not be good news. Gordon said the report points to increased scrutiny of federal tax expenditures and potential loopholes for high-income earners, wealthy individuals, or large corporations.

“That’s pretty broad. We don’t know how that’s going to show up in the budget,” he says. “It could become a bit of a political flashpoint where on one hand, some people will say it’s good, and other people will say ‘I’ve already paid my just dues'.”

One area in focus is Canada’s alternative minimum tax regime, under which it seeks to ensure all individuals pay their fair share of taxes and prevent undue reductions of taxes. Roughly, this would require individual taxpayers to calculate their taxable income twice: once to determine their regular tax, and then again to determine their “adjusted taxable income” which would determine whether they are subject to an alternative minimum tax (AMT).

“In 2021, the Liberal Party platform included comments about artificial reductions by high-income earners in our tax base. The last budget also flagged that, though the commentary was dialled down a bit,” Brian Ernewein, senior advisor, National Tax at KPMG in Canada, told Wealth Professional. “The government seems to be focused on ensuring that people at higher income levels, those earning $400,000 or more, don’t pay a tax rate of less than 15% federally.” 

The government has several options to accomplish that objective, including raising the tax rate on capital gains, or possibly on dividends. It could also limit a taxpayer’s ability to use charitable donations, stock options deductions, or apply loss carryovers, Ernewein (pictured above, right) says. 

“Based on our research, a large majority of taxpayers in that income group who pay lower than the 15% federal tax rate do so because of capital gains,” he says. “These are often one-time events, like a small business owner selling their shares, a farmer selling the family farm, or even someone selling their cottage.” 

As Ernewein explains, those who pay the alternative minimum tax may be entitled to get back what they paid in succeeding years if their regular income tax bill exceeds their AMT liability. But many taxpayers who may have more than $400,000 from a one-time event don’t have sufficient regular income tax afterwards to recover an outsized AMT tax bill. 

“You can end up with a situation where a small business owner or farmer who’s sold their business isn’t able to recover after the higher AMT bill imposed on them from this one-time event,” he says.

The pre-budget report also included language about boosting economic growth through decreased regulation and compliance burdens on small and mid-sized business owners, which Gordon says could be helpful for his clients. In KPMG Canada’s polling of medium-sized companies, 83% agreed there should be more tax relief to encourage businesses to reinvest in their operations and hire more workers.

Another potential silver lining would be employee ownership trusts, which would essentially help more small business owners to transfer ownership to their employees. Among the business owners polled by KPMG Canada, 80% want the government to follow the U.K.’s lead of eliminating capital gains taxes for business owners who sell the majority of their company to an EOT.

“The good news is that the government seems to have already expressed a commitment to implementing measures to facilitate employee ownership trusts,” Ernewein says. “They talked about it in two successive budgets.”

While it’s always possible for an entrepreneur to sell their business to employees, an outright sale can lead to dramatic tax consequences. The “secret sauce” to EOTs, Ernewein says, is the ability to transfer ownership of the business to the trust with payments to the owner over time. The government may set up rules so for EOTs to receive shares of the business over time on a rollover basis or cost basis, but the exact structure around it remains to be seen.

Citing a January report by the Canadian Federation of Independent Business titled “The Succession Tsunami,” Gordon says 76% of business owners plan to exit their business in the next decade, but aren’t able to find suitable buyers.

“You see them in the States. I’m a Certified Exit Planning Advisor, and when I went through the CEPA curriculum, it talked about transitions like this,” he says. “We’ve got to start putting something in place, because business owners are looking to transition with not much place to go.

“A lot of their kids, quite frankly, just don’t want to take over these businesses. If the update could provide that as a solution, that would be amazing.”