2024 was a year of uncertainty surrounding the potential increase of capital gain inclusion rates from 50% to 66.7%. Many clients were struggling with the decision of whether or not to trigger capital gains prior to the proposed June 25, 2024 implementation date. Some triggered large gains in advance, some were too late to act or unable to trigger gains, while others chose to avoid paying the tax upfront and deferred the unrealized gain to the future.
In January 2025, Justin Trudeau announced his resignation and prorogued parliament resulting in the subsequent delay to the implementation of these rules until January 1, 2026. While it’s certainly possible that a new government may come into power in 2025 and these rules do not ultimately pass, what is clear is that this delayed implementation date presents another opportunity to take advantage of the current lower tax rates.
It may seem counterintuitive, however deliberately triggering a capital gain can actually reduce your tax bill. Let’s use an example of a dentist that is currently in the top personal marginal tax rate and would like to withdraw an extra $100,000 from her corporation. The tax rate on regular dividend income is 48.9% therefore she would only get to keep $51,000 with $49,000 going to tax. She is wondering if there is a better way, knowing that she will likely be in the top tax bracket for many years ahead.
There is a technique often referred to as a CDA strip which can lower her overall tax cost. The key is the use of the Capital Dividend Account (“CDA”). Let’s assume she has certain stocks in her corporate investment portfolio that have doubled in value over the years with a cost of $100,000 and a current market value of $200,000. Having the investment advisor trigger a gain of $100,000 will create $50,000 of CDA room. She does not have to withdraw any money from the corporate investment portfolio. Instead, she can continue to reinvest in the same shares she previously held, but triggering the gain will end up reducing her overall taxation.
As only half of a capital gain is taxable, $50,000 is the amount that would face capital gains taxation. The corporate tax rate on passive income is 50.67%, however 30.67% is refundable when sufficient dividends are declared to the shareholders, therefore the net corporate tax will be approximately 20% or $10,000.
After tax personal proceeds calculated as:
$50,000 CDA (tax free dividend)
40,000 Taxable dividend from the company ($50,000 minus the $10,000 in corp tax above)
(19,500) Personal tax on the taxable dividend ($40,000 x 48.9%)
$70,500 Net after tax personal funds
(51,000) After tax personal funds of $100,000 regular dividend outlined above
$19,500 Total tax savings
As a result, triggering capital gains of $100,000 saved $19,500 of tax compared to withdrawing $100,000 without any gain!
Passive Income Grind
The gain triggered $50,000 of passive income, which is the allowable limit before the dental practice begins to lose $5 of Small Business Deduction (“SBD”) for every additional $1 of passive income that exceeds $50,000. Loss of the SBD would result in a corporate tax rate of 27% rather than the SBD rate of 11%. However, it is important to note that the increased corporate tax is not a permanent tax but only a loss of tax deferral. The income that was subject to the higher 27% corporate tax rate can later be distributed to the shareholders as an “eligible” dividend which is taxed at a much lower tax rate of only 36.5% as compared to the 48.9% tax rate of regular dividends. For instance, if these funds are withdrawn in the subsequent year, there is no loss of tax deferral and no increase in overall tax incurred. Therefore, consideration should be taken as to how much of a capital gain to trigger. If the first example was modified and $200,000 was needed annually, a passive income grind would result.
After tax personal proceeds calculated as:
Year 1 – $200k capital gains and $200k disbursement
$100,000 CDA (tax free dividend)
80,000 Regular dividend from the company ($100,000 minus $20,000 in corp tax)
(39,000) Personal tax on the regular dividend at 48.9%
$141,000 Net after tax personal funds
Year 2 – $200k disbursement
$40,000 Increase in corporate tax (reduction in SBD limit of $250k x 27%-11% = $40k)
$160,000 Eligible dividend from the company
(58,500) Personal tax on the eligible dividend at 36.5%
$101,500 Net after tax personal funds
As illustrated above, the net after tax personal funds were $141,000 in year 1 and $101,500 in year 2, totaling $242,500. Had the $200,000 drawn in year 1 and the $200,000 in year 2 been taxed as regular dividends at 48.9%, the total tax would have been $195,500 leaving you with $204,500 after tax. Even with the passive income grind, the tax savings of utilizing the strategy over the two-year period total $38,000!
The beauty of this tax planning is its simplicity to implement. No complicated share reorganization is involved. As long as you have investments inside your corporation with accrued gains, it’s simply a matter of how much gain to trigger and when.
