Read our January 31, 2025, update: Capital gains tax rate changes: A clearer picture for taxpayers

Justin Trudeau recently indicated that he would be resigning from his position as the Prime Minister of Canada and requested that Parliament be prorogued until March 24, 2025, which was approved by the Governor General. The prorogation of Parliament will impact proposed changes to the Income Tax Act (Canada) (the “Tax Act”) which have not yet received Royal Assent, including the proposed change to increase the capital gains inclusion rate from one-half to two-thirds.

Background – Capital gains inclusion rate increase

On April 16, 2024, the Canadian federal budget (the “2024 Budget”) was tabled. One of the key proposals set out in the 2024 Budget was an increase in the capital gains inclusion rate for capital gains realized on or after June 25, 2024.

The capital gains inclusion rate was to increase to two-thirds (from one-half) for capital gains realized by corporations and trusts, and to two-thirds (from one-half) on the portion of capital gains realized in a year that exceed $250,000 for individuals and certain trusts.

Current status of the proposed changes introduced by the 2024 Budget

To introduce a bill that creates, extends, increases or continues a tax, the House of Commons must adopt a Ways and Means motion.

Notices of Ways and Means motion (“NWMM”) were tabled on June 10, 2024, August 12, 2024, and September 23, 2024, to introduce a bill that included, inter alia, the increase in the capital gains inclusion rate described above and technical changes required to support the increase to the inclusion rate. The NWMM also included transition rules as the changes were to take effect in the middle of the 2024 taxation year.

The proposed legislation did not receive Royal Assent prior to Parliament being prorogued. Accordingly, the proposed change to the capital gains inclusion rate is not currently law.

The Canada Revenue Agency’s position on administering the proposed legislative amendments

Despite the proposed legislative amendments not receiving Royal Assent, the Canada Revenue Agency (the “CRA”) has indicated that they will administer the proposed changes to the capital gains inclusion rate effective June 25, 2024, in a manner consistent with the proposed legislative amendments set out in the NWMMs.

It has traditionally been the CRA’s administrative policy to administer tax proposals as though they were effective as soon as the NWMM in respect of particular proposals is tabled. According to the CRA, this approach provides consistency and fairness in the treatment of all taxpayers.  Generally, proposed legislative amendments tabled in a federal budget and NWMM will receive Royal Assent sometime thereafter.

The CRA has commented that their administrative position regarding the administration of tax proposals will not be affected by Parliament’s prorogation. However, the CRA has also stated that upon resumption of Parliament, if no bill is passed in the House of Commons, and the government indicates its intent to not proceed with the proposed changes to the capital gains inclusion rate, the CRA would cease to administer them.

The CRA cannot require taxpayers to file their income tax returns on the basis of the proposed legislation set out in the NWMMs.  In particular, section 12.3.5 of the CRA Income Tax Audit Manual provides guidelines for the CRA with respect to dealing with proposed legislative amendments. Specifically, it states that if the proposed legislation is not beneficial to a taxpayer, the CRA cannot require the taxpayer to file on the basis of proposed legislation.

In such cases, the CRA should inform the taxpayer that the taxpayer is responsible to apply the legislation according to the enacted legislation after Royal Assent. The taxpayer may then be subject to interest on amounts owing once Royal Assent is granted.

However, it is uncertain at this time if the proposed legislative amendments will ever receive Royal Assent. Generally, when Parliament is prorogued, a bill that has not received Royal Assent is removed from the Order Paper. As of December 17, 2024 the bill to amend the Tax Act had not yet been removed from the Order Paper.

Upcoming decisions for taxpayers

Taxpayers who disposed of capital property in 2024 will face difficult decisions in the coming months as tax season is around the corner.

As noted above, it is impossible to predict what will become of the proposed legislative amendments to the capital gains inclusion rate, and we may not derive certainty from the government before income tax return filing deadlines. This begs the question: what should taxpayers do in the circumstance?

Regardless of what taxpayers decide, they should expect that the CRA will administer the proposed legislation set out in the tabled NWMMs until further notice.

For those taxpayers who engaged in transactions on or before June 24, 2024, to dispose of capital property in a manner that permitted the taxpayer to elect whether or not to realize a gain on such disposition, a decision will need to be made whether to elect to have disposed of the capital property for proceeds equal to their adjusted cost base or fair market value. The former providing for a tax-deferred rollover, while the latter realizes a taxable capital gain for the taxpayer.

Pay taxes based on proposed amendments

For those taxpayers who disposed of capital property on or after June 25, 2024, they can file their 2024 income tax returns and pay taxes based on how the CRA is administering the proposed legislative amendments – i.e., with the proposed higher rates for capital gains realized after June 24, 2024.

Taxpayers who follow the proposed rules will have to file an amended return or object to the notice of assessment to facilitate a refund on the overpaid tax if the proposed legislative amendments to capital gains tax do not receive Royal Assent.

Subsection 164(1) of the Tax Act provides the statutory authority for the making of refunds of overpaid tax, interest and penalties by the Minister of National Revenue – i.e., the CRA, provided that the taxpayer’s tax return has been filed within three years from the end of the year or the fairness provisions in subsection 164(1.5) of the Tax Act are applied. Subsection 164(3) of the Tax Act provides that interest is payable at the prescribed rate on an overpayment of tax refunded under subsection 164(1) of the Tax Act.

Pay taxes based on current tax law

Alternatively, taxpayers may choose to file their 2024 income tax returns and pay tax on capital gains realized after June 24, 2024, based on the current tax laws, which apply the one-half capital gains inclusion rate. This approach would not be incorrect, given that the proposed legislation has not yet received Royal Assent.

However, this decision carries some risk. The CRA could reassess the taxpayer if the proposed legislation receives Royal Assent, requiring the taxpayer to pay additional tax to cover the difference in the inclusion rate, plus interest. Penalties are unlikely to apply in this situation, as the conditions for most penalty provisions under the Tax Act would not be met. However, we caution that some penalty provisions, such as section 163.1 of the Tax Act, may be applicable in the circumstance in the event that a reassessment is raised.

In addition to the interest payable at the prescribed rates for a late or deficient filing, where taxpayers are required to pay interim instalments of tax, section 163.1 imposes a penalty if the interest payable in respect of all instalments for the year exceeds the greater of (i) $1,000, and (ii) 25% of the interest that would be payable in respect of all instalments  for the year if no instalments were paid for the year.

The potential impact on certain tax attributes

Whether taxpayers file under the one-half or two-thirds capital gains inclusion rate could have a cascading effect on several important tax attributes. A higher inclusion rate would decrease a corporation’s capital dividend account (as defined under subsection 89(1) of the Tax Act), enabling a reduced amount of capital dividends to be paid tax-free, and potentially increase the Refundable Dividend Tax on Hand (“RDTOH”) balance, allowing for greater refunds upon taxable dividend distributions. It could also increase aggregate investment income, which could grind down a corporation’s small business deduction (the “SBD”), if eligible, increasing overall tax rates and reducing the corporation’s tax efficiency.

If the proposed capital gains inclusion rate change does not receive Royal Assent, corporations that filed under the assumption of the higher rate could face cascading effects in their capital dividend account balance, RDTOH balance, and aggregate investment income. These effects could result in underpayment of capital dividends, incorrect RDTOH refunds, and miscalculated eligibility for the SBD, potentially leading to unnecessary tax payments, administrative burdens, and penalties. Corporations should stay vigilant about legislative developments and be prepared to adjust their filings accordingly.

Please note that this publication presents an overview of notable legal trends and related updates. It is intended for informational purposes and not as a replacement for detailed legal advice. If you need guidance tailored to your specific circumstances, please contact one of the authors or a member of our taxation team to explore how we can help you navigate your legal needs.

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