Why a Tax on Vacant Land Could Backfire

While a vacant land tax might initially seem like a push for faster development, it could create unintended consequences. Free-market economists argue that such taxes can distort economic behaviour, particularly affecting smaller developers who may struggle with the added financial pressure. Larger developers could pass the costs onto homebuyers, worsening the housing affordability crisis. Studies in other countries show that, while the tax might initially encourage more land to be developed, this effect is likely temporary. Over time, developers may hold less vacant land, reducing their flexibility and the overall responsiveness of housing supply, exacerbating the housing shortage rather than solving it.

The Reality in Canada

Some studies on vacant land reveal that the reason for land remaining vacant was not as a result of owners holding it for speculative purposes rather that the cost of development was often too high. Evidence shows that government policies limiting the supply of housing are among the key causes of higher house prices. Studies show that, a single-detached home in Vancouver cost the home buyers $1.3 million more than it would have in a market without barriers to supply. Similarly, homes in the Toronto area now cost homebuyers an additional $350,000.

Instead of taxing real estate developers, it would be smarter to offer tax incentives to build sooner. Immediate tax breaks would motivate developers to start projects now, rather than holding out for higher returns in the future. One example is to reduce the tax rate for developers who successfully build homes, allow them to deduct interest costs during the period of construction, especially for those who reinvest the profits back into the business.

Canada’s Poor Track Record with Recent Tax Policies

Canada’s own history with new tax measures has shown inefficiency. The Underused Housing Tax and new bare trust reporting rules, for example, were poorly implemented, leading to confusion and last-minute relief measures. These didn’t raise much government revenues, and the costs to administer the UHT could “significantly reduce” revenue generated. Given these experiences, adding another layer of red tape with a vacant land tax could bog down the system and hurt productivity, instead of solving the housing crisis.

Recent tax measures like the UHT reveal that the CRA may not be equipped to handle the administration of this tax. There are fundamental grey areas that CRA employees need to make a judgement on:

1. What is considered “Vacant” Land?
2. Does someone’s extra large backyard count as “vacant land”?
3. What if a person can’t develop due to ongoing estate litigation or other hurdles?
4. What if a person can’t develop due to the costs?
5. What is the fair market value of the vacant land?

The CRA will need to employ people who understand zoning laws inside out and add another department filled with agents, auditors, administrators, lawyers, accountants, professional appraisers, and real estate experts. What is all this going to cost the average taxpayer?

Let’s Learn from Ireland’s Example

Ireland’s Vacant Site Levy was introduced in 2017 and phased in gradually. Initially set at 3% of the site’s market value in 2018, it was increased to 7% from 2019 onward. The levy applies annually to vacant or underutilized land in designated residential and regeneration zones, with landowners assessed based on the site’s market value.

Ireland’s experience with the Vacant Site Levy, as outlined in a report by the Parliamentary Budget Office (Challenges in Implementing and Administering the Vacant Site Levy), provides vital lessons for Canada. The report highlights issues like inconsistent enforcement, unclear definitions of “vacant land,” and administrative complexity, which undermined the policy’s effectiveness. If Canada proceeds with a vacant land tax, it will face similar challenges, leading to inefficiencies rather than solutions.

A Tax Incentive: A True Partnership Between Government and Taxpayers

A tax incentive approach represents more than just policy—it’s a partnership between the government and real-estate developers. Offering tax breaks to developers acknowledges their role in solving the housing problem while also providing mutual benefits. Developers receive immediate financial relief and are more likely to act quickly, while the government sees faster housing development and increased economic activity. By working together, both sides align in achieving a common goal: increasing the housing supply to meet the urgent needs of the population.

Why Tax Breaks Are a Better Solution

Tax incentives, such as reduced development costs or tax deductions/holidays, can speed up the decision-making process for developers. They would feel encouraged to start building immediately, knowing they’re receiving direct benefits for doing so. This avoids the potential drawbacks of punitive taxes and keeps housing development on track, with benefits flowing to everyone involved. The UK provided tax incentives such as Land Remediation Relief, which offered a 150% tax deduction for developers dealing with contaminated land, making redevelopment more financially attractive. Such relief will help offset cleanup costs, encouraging the use of previously neglected or derelict urban land.

Conclusion

Canada needs actionable solutions to address the housing shortage, but a vacant land tax is unlikely to provide the results the government hopes for. Examples from other countries show the pitfalls of such policies, and Canada’s recent tax missteps with the underused housing tax suggest a similar risk. Instead, tax breaks and incentives offer a practical way to work in partnership with developers, ensuring mutual benefits and a faster path to more housing. This collaborative approach could be the key to addressing Canada’s housing crisis effectively.

The government is seeking consultations on this new tax, so feel free to email your comments and feedback to VLT-TTV@fin.gc.ca.

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Key Reforms Announced

The reforms, as outlined by Chrystia Freeland, Minister of Finance, include several measures designed to help Canadians enter the housing market:

1. Raising the Cap on Insured Mortgages: The government has increased the insured-mortgage price cap from $1 million to $1.5 million. This adjustment reflects the steep rise in housing prices, enabling buyers to purchase more expensive homes with down payments of less than 20%.
2. Extended Mortgage Amortization for First-Time Buyers: The government is allowing first-time homebuyers and purchasers of new builds, including condos, to access 30-year amortizations. This reduces monthly mortgage payments, providing short-term financial relief and increasing eligibility for mortgages.
3. Incentives for New Housing Construction: The federal government has also announced investments in infrastructure to support the construction of 4 million new homes. This move aims to tackle the country’s housing shortage by spurring new builds and enabling more supply in the market.

The Numbers Tell a Different Story

While these reforms aim to alleviate the financial stress of homeownership, an analysis of the numbers tells a more concerning story for young Canadians.

Let’s consider a scenario where you purchase a $1.2 million home with a 5% interest rate and a 30-year amortization. We’ll compare the monthly payments at various down payment levels. To live comfortably and avoid becoming “house-poor,” financial experts recommend keeping mortgage payments within 25% to 30% of after-tax income. We’ll also examine the income a single person and a married couple would need to comfortably afford these mortgage payments while staying within that recommended range.

For example, to afford a home worth $1.2 million with a 5% down payment, without overextending financially, a single Canadian would need to earn approximately $440,000 annually before tax, or a couple would need a combined income of $370,000. In stark contrast, the average income for Canadians aged 25 to 54 is around $68,000. This is why we believe this measure could end up hurting young Canadians than help in the long run. This could strain them financially, and could force them to make sacrifices in other areas of life, which could lead to more stress and increased mental health issues.

What This Means for Young Canadians?

While the government’s recent reforms are designed to help young Canadians achieve the dream of homeownership, the numbers reveal potential pitfalls.

• Stretching Young Canadians Thin: With the average home price in Toronto hovering around $1.1 million, even with extended amortizations, young Canadians will likely find themselves stretched. They may achieve lower monthly payments, but at the cost of taking on more debt and paying significantly more in interest over time. If interest rates go up in the future, variable interest borrowers could face unpleasant surprises in their monthly expenses.
• Jeopardizing Other Financial Goals: Spending a large portion of income on housing can leave young homeowners with little room for other expenses, including savings for retirement or emergency funds. By enabling buyers to take on more debt, these reforms might drive home prices even higher in the long run, exacerbating affordability issues. While the reforms might temporarily ease the burden, they do little to address underlying supply shortages, which continue to drive prices up. Higher debt loads may also lead to long-term financial instability for homeowners.
• Risk to Retirement: While monthly payments may become more manageable in the short term, the overall increase in total interest paid over the life of the loan may leave homeowners with less room to save for retirement or handle unexpected expenses. This could result in an increased reliance on credit or loans, further deepening financial vulnerability. This is particularly concerning in Canada, which has one of the highest household debt levels per capita among G7 countries[2] [3].

Conclusion

While the government’s mortgage reforms may provide some immediate relief to aspiring homeowners, they ultimately don’t address the deeper affordability crisis in Canada’s housing market. By raising the insured-mortgage cap and extending amortization periods, the government may inadvertently fuel further price increases, making it even harder for young Canadians to afford homes in the future. The focus should be on reducing barriers to building more homes, particularly in high-demand areas like Toronto and Vancouver, rather than enabling buyers to purchase homes they cannot truly afford.

For Millennials and Gen Z, these reforms may offer a temporary leg up, but the dream of owning a home remains elusive for many—especially without broader policy changes that address income inequality and the rising cost of living in major urban centers. As housing prices continue to soar, financial prudence and careful budgeting are more critical than ever for those navigating the increasingly difficult path to homeownership.

We’ve helped many small business owners enter the housing market tax-efficiently, maximizing after-tax income so you don’t become house-rich but cash-poor. If you’re a small business owner or incorporated professional looking for tax-smart strategies to buy a home, give us a shout.

Footnotes

[1] Government announces mortgage reform details to ensure Canadians can access lower monthly mortgage payments by December 15 – Canada.ca

[2] Canada’s household debt is now highest in the G7 (bbc.com)

[3] Research to Insights: Disparities in Wealth and Debt Among Canadian Households (statcan.gc.ca)

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The government released draft legislation in August. In this article, we answer some key questions and discuss what we would like to see ironed out in the final version of the legislation.

Who Qualifies?

The Canadian Entrepreneurs’ Incentive is available where all the following conditions are met:

1. QSBC Shares: At the time of sale, the individual Claimant must directly sell qualified small business corporation shares[1]. One requirement is that 90% of the corporation’s value is derived from assets used in an active business carried on in Canada (other than the “excluded businesses” mentioned below).
   
2. 24-Month Holding Period and Minimum Ownership: For at least 24 continuous months before the sale, the claimant must have owned at least 5% of the shares (having full voting rights under all circumstances). The minimum ownership period can be any continuous 24-month period at any time since the business’ founding[2].
   
3. Active Engagement: The claimant was actively engaged in the business activities on a regular, continuous, and substantial basis for three years. This can be any combined three-year period at any time since the founding of the business[3].

Not Available to Which Businesses?

The following are considered “excluded businesses”. If you have capital gains from the sale of the following businesses, you do not qualify for the CEI.

• Professionals: such as accountants, lawyers, notaries, doctors, mental health practitioners, healthcare workers, veterinarians, optometrists, dentists, chiropractors, engineers, or architects.
• Businesses where the main asset is employee expertise or reputation.
• Consulting services.
• Financial Services: handling financial assets, transactions, credit facilitation, or changing ownership of assets.
• Insurance Services: covering underwriting, selling insurance, reinsurance, or related services.
• Property Services: appraising, renting, leasing, selling, or managing real property, including short-term lodging or vacation services, like hotels and campgrounds.
• Food and Beverage: preparing and serving food for immediate consumption.
• Cultural & Entertainment: running events, exhibits, sports, and recreation services, or showcasing historical and artistic interests.

When Does it Take Effect?

CEI would apply to sales that occur on or after January 1, 2025.

What if I Claim the Lifetime Capital Gains Exemption?

The CEI would apply in addition to any available capital gains exemption. To the extent that the seller qualifies for both the lifetime capital gains exemption (LCGE) and the CEI, they can take advantage of both tax incentives. See the example below.

Can I Undertake a Corporate Reorganization to Qualify for CEI?

There are some anti-tax avoidance rules to watch out for.

First, there are rules to prevent using what is commonly known as “butterfly” transactions, where corporate assets are split off or sold to convert the corporate capital gain into a capital gain that qualifies for the CEI.

Second, there are also rules to deny the CEI, where a corporation sells assets to another corporation for less than the fair market value of the assets, and an individual realizes a capital gain on the sale of the shares of either corporation.

Rules to Prevent Converting Dividends to Canadian Entrepreneurs’ Incentive

Normally, dividends are taxed higher than capital gains. Some people might try to avoid paying tax on dividends by setting up shares that don’t pay dividends or pay very low dividends. Instead, they plan to sell these shares later at a high price and claim the CEI. There is an anti-tax avoidance rule that says you cannot claim the CEI if the capital gain you made from selling shares is because the company didn’t pay enough dividends (less than 90% of what would be a normal return on that share). The dividend that should be paid be equal to the rate of return that a knowledgeable and prudent investor would expect to receive.

While this rule aims to prevent tax avoidance, it introduces a level of uncertainty and subjectivity. Determining what constitutes a “normal return” or what a “prudent investor” would expect may lead to inconsistent interpretations. This could create challenges for business owners and shareholders, adding complexity and risk, especially in cases where companies have legitimate reasons for reinvesting profits rather than paying dividends. It raises the question: is the Canada Revenue Agency (CRA) best positioned to make these determinations about what constitutes a reasonable rate of return?

Given the nuanced and varied nature of private business operations, it may be difficult for the CRA to consistently assess what an appropriate dividend payout would be for each business. First, it could discourage reinvestment in businesses requiring growth capital or create uncertainties for entrepreneurs trying to plan for the future. Second, it adds more red tape and work for CRA. As such, we believe that this anti-avoidance rule may not be the most effective approach and would benefit from further clarification or guidelines to provide more certainty and reduce the risk of inconsistent application.

Example: Sale in 2029

In 2029, Larry sells the shares of his tech business for $3 million. Let’s assume that Larry has $1 million remaining in the Lifetime Capital Gains Exemption (LCGE) and that the sale qualifies for the CEI.

After applying his remaining LCGE of $1 million, Larry has $2 million in capital gains left. Under normal rules, with a two-thirds inclusion rate and a $250,000 capital gains allowance at a 50% inclusion rate, $1,291,667 would be taxable. However, with the CEI, the inclusion rate drops to one-third, so only $666,667 is taxable. At Ontario’s top tax rate of 53.53%, this results in estimated tax savings of around $335,000. As you can see the benefit could be significant.

Canadian Entrepreneurs’ Incentive and Family Trust Structure

Please note that these rules are still in draft form at the time of writing, and further clarification may be needed as the legislation evolves.

One notable comparison is with the LCGE, which allows individuals to claim a deduction on capital gains from the sale of Qualified Small Business Corporation (QSBC) shares. If a trust allocates capital gains from such shares to a beneficiary, the beneficiary may claim the LCGE, provided the shares meet the necessary qualification criteria.

In contrast, the CEI, based on the draft legislation, seems to apply more narrowly. It appears to exclude gains on trust-held property from eligibility, meaning that even if a trust allocates the gain to a beneficiary, the CEI deduction may not be claimed. The CEI is reserved for individuals who directly own and sell the qualifying shares. As a result, gains allocated through a trust may not qualify for the CEI, even if the shares themselves would otherwise meet the criteria. This is a key difference from the LCGE, which allows trust-allocated gains to flow to beneficiaries. However, if a trust rolls out shares to an individual beneficiary just before the sale, and the beneficiary sells them directly, the CEI may apply. In this scenario, the beneficiary is considered the direct owner of the shares, and if all CEI conditions are met, they may claim the deduction, avoiding the trust exclusion.

Our Comments on the Daft Legislation

The benefit is good for entrepreneurs. However, we are hoping future versions of the legislation will:

1. Address Family Trust Structures: Address issues like trust ownership with more clarity so that entrepreneurs with more complex structures – including family trusts – can qualify.
   
2. Expand the list of qualifying businesses: Under the draft rules, businesses whose “main asset is employee expertise or reputation” are explicitly excluded from CEI eligibility. However, these types of businesses, such as a dental practice or a consulting firm, often assume significant risks and play a key role in Canada’s entrepreneurial ecosystem. A dentist running their practice does not qualify. Similarly, a marketing consultancy or software development firm may also be ineligible because their main assets are tied to the knowledge and skills of their employees. Despite this, these businesses require substantial investment, face market volatility, and carry considerable operational risks. By expanding eligibility to include more “expertise-based” businesses, the CEI could better reflect the entrepreneurial spirit across a broader range of industries, aligning it more closely with the LCGE and supporting a broader range of business owners. One suggestion is to allow businesses exceeding a certain number of employees to qualify (such as more than 5 full-time employees).
   
3. Remove Rules to Prevent Converting Dividends to CEI: Many small businesses reinvest profits instead of paying dividends. These rules introduce unnecessary uncertainty and complexity, potentially discouraging small business owners from utilizing the benefit due to concerns that the CRA may later reverse the claim. The business cannot be cash-rich anyway because of the QSBC test, which requires 90% of the value of the assets to be deployed in an active business. So, this may not be required.

Footnotes:

[1] Note the property could also be qualified farm or fishing property, but we only cover this article in the context of qualified small business corporation shares.

[2] Government announces details on new Canadian Entrepreneurs’ Incentive – Canada.ca

[3] See note 2.

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Last year’s tax season was challenging, with the government introducing a new requirement for bare trusts to file trust tax returns for the first time. Fortunately, at the last minute, the CRA announced that bare trusts would not need to file for 2023. This change came after recognizing the unintended impact on Canadians, particularly those with joint bank accounts or where parents were added to property titles to help their children secure mortgages.

Looking ahead to 2024, there’s good news. Recently released draft legislation confirms that bare trusts (that are otherwise not considered to be a “trust”) will also be exempt from filing tax returns in 2024. However, starting in 2025, bare trusts will need to file, with some exceptions, including:

• Arrangements where individuals jointly own property for their own use and benefit, such as joint bank accounts with family members.
• Situations where related individuals hold real property, such as when a parent is on title to help a child obtain a mortgage, and the property qualifies as a principal residence.
• Cases where real property is held by one spouse for the benefit of the other, where it serves as their principal residence.
• Partnerships (excluding limited partners) holding property for the partnership’s use or benefit.
• Instances where property is held under a court order.
• Arrangements where Canadian resource property is held for the benefit of publicly listed companies or their subsidiaries.
• Non-profits holding funds received from government bodies for the benefit of other non-profits.

New rules, effective for trusts with a December 31, 2025, taxation year-end, specify that a trust is deemed to include any arrangement where:

• One or more persons (the legal owners) hold property for the use or benefit of one or more persons or partnerships, and
• The legal owner can reasonably be considered to act as an agent for the persons or partnerships benefiting from the property.

Under these rules:

• Each legal owner in such an arrangement is deemed to be a trustee of the trust, and
• Each person or partnership that benefits from the property is deemed to be a beneficiary of the trust.

These exemptions provide some relief, ensuring that many common arrangements won’t trigger the filing requirement.

Beneficial Ownership Information

In 2023, all trusts were required to file a tax return and disclose detailed information about settlors, beneficiaries, and trustees through Schedule 15. However, an exemption existed for “Listed Trusts.” A Listed Trust was one that held assets with a total fair market value below $50,000 throughout the year, provided the assets were restricted to certain types, such as:

• Money,
• Certain government debt obligations,
• Listed shares, debt obligations, or rights,
• Mutual fund shares or units,
• Interests in related segregated funds,
• Beneficiary interests in listed trusts.

Listed Trusts only had to file a trust return if income from the trust property is subject to tax. However, it was exempt from filing Schedule 15.

The good news is that starting in 2024, for trusts with a December 31 year-end, Listed Trusts will include any trust where the total fair market value of its assets remains below $50,000 throughout the year, regardless of the types of assets it holds.

Additionally, a trust will qualify as a Listed Trust if:

• Each trustee and beneficiary is an individual,
• Each beneficiary is related to each trustee, and
• The total fair market value of the trust’s assets does not exceed $250,000 throughout the year, provided those assets are limited to money, GICs, certain debt obligations, listed securities, mutual fund units or shares, personal-use property, or rights to income from such assets.
• If these Listed Trusts have no tax payable, they are not required to file a tax return. If they do, they won’t need to file Schedule 15.

This means a Listed Trust with no tax does not need to file a trust return. If a Listed Trust does have to pay tax, it is still relieved from filing Schedule 15.

These changes simplify the filing requirements for smaller and family trusts, providing more flexibility. Note that, at the time of writing, these changes are still in draft.

The post Tax Filing Relief for Trusts in 2024 and Beyond appeared first on LRK Tax LLP.

For those in the top tax bracket, qualifying for this $250,000 capital gains allowance can save $22,000 in taxes. Many taxpayers are now looking for ways to multiply this benefit—especially by using spousal transfers.

How to Multiply the $250,000 Capital Gains Allowance with Your Spouse

One strategy to multiply the capital gains allowance is to split capital gains with a spouse, without triggering the attribution rules, which prevent income splitting. By following the correct steps, each spouse can claim the $250,000 allowance and reduce the overall tax liability.

Example: Andrew and Jane

Andrew and Jane are married, and Andrew owns a stock worth $100,000, which he bought for the same amount. He predicts the stock’s value will grow to $600,000 in one year. To maximize the capital gains allowance, Andrew takes the following steps:

1. Sell Half the Stock to Jane at Fair Market Value – Andrew sells half of his stock to Jane for $50,000, which is the fair market value. This avoids triggering attribution rules.
2. Elect Out of the Spousal Rollover – Normally, when you transfer assets to your spouse, a spousal rollover defers the tax on any unrealized capital gains. However, in this case, Andrew elects out of the rollover to ensure that Jane’s future capital gains and investment income are not attributed back to him. Jane issues Andrew a promissory note for $50,000 with an interest rate set at the CRA’s prescribed rate (currently 5%, though this rate may change as interest rates fluctuate).
3. Cost Basis Adjustment – Both now hold half of the stock with a cost basis of $50,000 each.
4. Stock Appreciates to $600,000 –After a year, the stock grows to $600,000, and both sell the stock, resulting in a $500,000 capital gain. Andrew and Jane each realize a $250,000 gain ($300,000 – $50,000).
5. Interest on the Loan –Jane pays Andrew $2,500 in interest (5% of $50,000), ensuring the attribution rules won’t apply.
6. Capital Gain Reporting
   • Andrew reports $250,000 in capital gains and $2,500 in interest income.
   • Jane reports $250,000 in capital gains and deducts the $2,500 interest as an expense.

Tax Savings Breakdown

• Total Capital Gains: $500,000
• Andrew’s Tax: Andrew reports $250,000 at the 1/2 inclusion rate, resulting in a taxable gain of $125,000.
• Jane’s Tax: Jane also reports $125,000 in taxable gains.
• Interest Treatment: Jane’s $2,500 interest payment reduces her taxable income while Andrew adds it to his.

If Andrew had reported the full $500,000 gain by himself, his tax bill would have been $156,000. By splitting the gains, their combined tax liability is $134,000, saving $22,000.

How This Strategy Works

This strategy doubles the capital gains allowance for married couples. Transferring assets at fair market value ensures the attribution rules don’t apply, allowing both spouses to claim the $250,000 capital gains allowance.

Final Thoughts

With the capital gains inclusion rate rising to 2/3 after June 25, 2024, taking advantage of the $250,000 allowance at the 1/2 inclusion rate is a valuable strategy for high-income taxpayers. Spousal transfers, like Andrew and Jane’s, can result in significant tax savings. However, with complex tax rules and potential scrutiny under the General Anti-Avoidance Rule (GAAR), careful planning is essential. Also note that the capital gains legislation is still in draft.

At LRK Tax LLP, our team can help you navigate these rules and maximize your tax benefits. Contact us today to learn how we can tailor your capital gains strategy.

The post How to Multiply Your Capital Gains Allowance Using Your Spouse: A Case Study appeared first on LRK Tax LLP.

The Small Business Deduction Eroded Faster Under New Rules

The small business deduction (SBD) in Canada offers significant tax relief to small businesses and entrepreneurs operating through Canadian-controlled private corporations (CCPCs). This deduction allows CCPCs to benefit from a lower corporate income tax rate on up to $500,000 of active business income annually, known as the corporation’s “business limit.”

In Ontario, eligible CCPCs benefit from a reduced tax rate of 12.2% under the SBD. However, the business limit is reduced on a straight-line basis when the “adjusted aggregate investment income” (i.e., passive income like rent, dividends, interest, and taxable capital gains) of the CCPC and its associated corporations falls between $50,000 and $150,000. We illustrate this with an example below.

Example: How the New Capital Gains Rate Also Increases Taxes on Business Income

Consider ACo, with a fiscal year from January 1 to December 31. Suppose ACo realizes a $225,000 capital gain in 2024 under the new capital gains inclusion rate, alongside $100,000 in regular business income in 2025.

Under the previous inclusion rate of 50%, ACo’s taxable capital gain would be $112,500. With the new inclusion rate of 66.67%, the taxable capital gain increases to $150,000.

This increase in taxable capital gain causes the tax on regular business income to also increase as follows:

• Under old rules, a $112,500 taxable capital gain would reduce the business limit by $312,500, resulting in an SBD after the grind of $187,500.
• Under new rules, a $150,000 taxable capital gain leads to a larger passive income grind of $500,000, effectively eliminating the SBD.
• Consequently, ACo faces a higher corporate tax rate on its business income, increasing from 12.2% to 26.5%, resulting in an additional tax burden of $14,300.

Under the old rules, assuming no other passive income, a corporation could realize between $100,000 and $300,000 in taxable capital gains without fully eroding the SBD. With the new inclusion rate, this range narrows to $75,000 to $225,000.

The Capital Gains Inclusion Hurts Small Business Owners and Entrepreneurs

Many small business owners and entrepreneurs, who often lack benefits like medical coverage and pensions, take risks to stimulate the economy by creating jobs, goods, and services. The lower business tax rate helps these entrepreneurs save for the future to offset risks. These business owners also have capital gains from selling off investments or rebalancing portfolios. Although the government asserts that the increased inclusion rate is fair and does not harm small business owners, this example illustrates the contrary.

A potential strategy for CCPCs might be to defer realizing capital gains in the hope that the inclusion rate might revert to the historical 50%. The capital gains tax in Canada, introduced in 1972 under Prime Minister Pierre Trudeau, initially included 50% of capital gains in taxable income. This rate was increased to 66.67% in 1988 and then to 75% in 1990 by the Progressive Conservative government to address budget deficits. Later, the Liberal government reduced the rate back to 66.67% in 2000 and then to 50% in 2001 to stimulate investment and economic growth. The 50% inclusion rate has been the most common, reflecting a balanced approach to encouraging investments.

Effective Tax Planning for Small Businesses

In conclusion, recent changes in capital gains inclusion rates emphasize the need for strategic tax planning to preserve small business wealth. As tax specialists, we are committed to helping small business owners and entrepreneurs navigate these challenges effectively. Our tailored strategies are designed to grow your wealth tax-efficiently amidst these new rules. Contact us today to explore how our expertise can support your business.

The post How the Capital Gains Inclusion Rate Increase Can Also Increase Tax on Small Business Income appeared first on LRK Tax LLP.

Understanding the Capital Gains Inclusion Rate Change

Under the current draft legislation, the capital gains inclusion rate is set at 2/3 for the taxpayer’s gains for the entire fiscal year. Transitional rules apply this rate to taxation years ending after June 24, 2024. For fiscal years that include June 25, 2024, such as January 1, 2024, to December 31, 2024, the inclusion rate is determined based on net gains or losses in two periods: Period 1 (January 1, 2024, to June 24, 2024) and Period 2 (June 25, 2024, to December 31, 2024).

First, you calculate the “net capital gain” and/or “net capital loss” in two periods: Period 1 (“P1”) from the start of the tax year to June 24, 2024, and Period 2 (“P2”) from June 25, 2024, to the end of the tax year. Then, the capital gains inclusion rate for the entire tax year is determined using the following rules:

Condition	Capital Gains Inclusion Rate for the Entire Tax Year
Only net capital gains P1 and P2
Only net capital losses P1 and P2
Net capital gains and losses are $0 in P2 and P2	2/3
Net capital gains in P1  > net capital losses in P2	1/2
Net capital losses P1 > net capital gains P2	1/2
Net capital gains P1 < net capital losses P2	2/3
Net capital losses P1 < net capital gains P2	2/3

In the above:

• A = Net capital gains or net capital losses from the first period.
• B = Net capital gains or net capital losses from the second period.
• The taxpayer’s net capital gains for a period are the amount by which their capital gains exceed their capital losses in that period.
• The taxpayer’s net capital losses for a period are the amount by which their capital losses exceed their capital gains in that period.

Example

Suppose ABC Inc. has a fiscal period ending December 31, 2024. Suppose the net capital gain in P1 (from January 1, 2024, to June 24, 2024) is $100,000 and $200,000 in the second period (June 25, 2024, to December 31, 2024). The inclusion rate would be approximately 61.11% using the formula above, which applies for the entire fiscal period from January 1, 2023, to December 31, 2023.

Therefore, the taxable capital gain is calculated as follows:

Most people expected the rules to apply a 1/2 inclusion rate to the $100,000 capital gain in P1 and a 2/3 inclusion rate to the $200,000 capital gain in P2 rather than using a blended rate for the entire gain.

Problem with Capital Dividends and Inclusion Rate

Even though the final taxable capital gain ($183,333.33) works out as expected, this has unintended negative consequences when determining the Capital Dividend Account (“CDA”).

Private corporations use the CDA to track non-taxable capital gains. From the CDA, corporations can pay capital dividends out of the CDA balance to shareholders, allowing them to receive tax-free income. The CDA is evaluated at a specific point in time to determine the balance available for paying out tax-free capital dividends. This means that when a corporation wants to declare a capital dividend, it must check the CDA balance at that particular moment to ensure there are sufficient non-taxable capital gains to cover the capital dividend.

Very generally, the CDA at a point in time is calculated as the corporation’s capital gain minus the taxable capital gain. Assuming that ABC Inc. had a $0 CDA balance at the start of the year, the CDA balance at the end of P1 (June 24, 2024) would only be $38,888.89 instead of what most would have expected of $50,000.

If the corporation had paid a $50,000 capital dividend to its shareholders on June 24, 2024, then it would have paid too much! The practical issue is that the corporation cannot accurately determine the exact amount to be added to the CDA until the end of the year when all capital gains and losses for both periods are known.

Penalties for Excess CDA

If a corporation declares a capital dividend exceeding its CDA balance, it faces a penalty equal to 60% of the excess amount declared. In our example, if the corporation declares a $50,000 dividend in P1 but the actual CDA balance is only $38,888.89, the excess amount of $11,111.11 would result in a penalty of $6,666.67.

Potential Solution or Work Arounds

To manage this uncertainty, a conservative approach can be taken by initially estimating the inclusion rate at the higher end (2/3). If, at year-end, the actual inclusion rate is lower, the CDA can be adjusted accordingly.

For instance, initially estimating an inclusion rate of 2/3 for a $100,000 gain in the first period would result in an estimated taxable gain of $66,667 and a CDA addition of $33,333. After realizing additional gains of $200,000 in the second period and recalculating the inclusion rate to 61.11%, the actual CDA addition would be $116,667, requiring an adjustment of $83,334.

Another solution is to create a fiscal period ending on or before June 24, 2024. This could be done by amalgamating two or more corporations or by transferring appreciated assets to a holding company with a fiscal period ending on or before June 24, 2024, before realizing gains. This allows the taxpayer to close off the current taxation year before June 24, 2024, thus avoiding the split-period calculation of the inclusion rate for capital gains. The issue here is that this may not be practical, given the complexity and only a few more days left.

Will Finance Fix This?

We understand that the Department of Finance is aware of technical issues like the above. However, no one knows for sure if they will fix it or not. Updated draft legislation will be made available at the end of July 2024, and we will need to wait until then to see if the government will fix it. Until then, it may be a good idea to only add 1/3 of the capital gains realized in P1 to the CDA balance.

The post Unexpected CDA Issues from New Capital Gain Inclusion Rate appeared first on LRK Tax LLP.

The Canadian government has recently implemented new reporting requirements for trusts[1]. These changes are in accordance with Canada’s international pledge to disclose beneficial ownership information and to maintain the efficiency and honesty of the Canadian tax system. However, the new rules are burdensome and have significant penalties for noncompliance.

Consider the scenario where you co-sign a mortgage for your child on a million-dollar home. This arrangement will likely be using a bare trust arrangement. If you were not aware and did not file tax returns (even though these would be nil returns, with no income), you could be subject to penalties of $50,000 per year plus interest. The current interest rate at the writing of this article is 10% compounded daily.

Unfortunately, these are the rules, and we feel that this new rule unfairly targets average Canadians without access to tax experts. For those Canadians who do have access to a tax specialist, these new rules would mean additional filing costs with little value in return. That is why we prepared a guide. This guide will explain the new rules and provide instructions on how to prepare a simple Nil return yourself for bare trusts with no activity other than legally owning an asset. 

Introduction: Trusts may need to file for the first time

Many trusts will be required to file a Trust return for the first time. Before the introduction of the new reporting requirements, a trust that did not earn income, dispose of capital property, or make distributions of income or capital in a year was generally optional to file a trust return.

The change in reporting requirements means that affected trusts will be required to file the following with the Canada Revenue Agency (CRA) every year:

Chapter 1: Which Trusts need to file a T3 Return?

Generally, all trusts that are required to file a T3 Return, other than:

• graduated rate estates and qualified disability trusts;
• mutual fund trusts, segregated funds and master trusts;
• trusts governed by registered plans (i.e., deferred profit sharing plans, pooled registered pension plans, registered disability savings plans, registered education savings plans, registered pension plans, registered retirement income funds, registered retirement savings plans, registered supplementary unemployment benefit plans and tax-free savings accounts);
• lawyers’ general trust accounts;
• trusts that qualify as non-profit organizations or registered charities; and
• trusts that have existed for less than three months or that hold less than $50,000 in assets throughout the taxation year (provided, in the latter case, that their holdings are confined to deposits, government debt obligations and listed securities).

For an explanation of the above trusts in more detail, please visit CRA’s website by clicking here.

Do Bare Trusts need to file a T3 Return?

Bare trusts are subject to the new trust reporting rules for tax years ending after December 30, 2023[1]. Accordingly, a bare trust is required to file a T3 Return annually unless specific conditions are met. A bare trust is also required to complete Schedule 15 annually. A bare trust with a December 31, 2023 tax year end must file a T3 Return for 2023.

The term “bare trust” is not defined in the Income Tax Act (the “Act”). However, a bare trust for income tax purposes includes a trust arrangement under which the trustee can reasonably be considered to act as an agent for all the beneficiaries under the trust with respect to all dealings with all of the trust’s property.

A bare trust could include a situation where you legally or are named as a legal owner of an asset or property, but the asset is held for the benefit of someone else. Following are some examples of arrangements that may be considered trusts and would be subject to the new reporting rules[2]:

1. Joint Ventures: Joint ventures are common in capital-intensive industries with multiple participants developing a project. Joint ventures usually have one participant to act on behalf of other participants (the “operator”) who may have expertise in certain types of developments. The operator typically holds legal title to the development property in trust for the other participants who beneficially own their proportionate interests in the joint venture property. In other words, the joint venture operator would likely be considered a bare trustee and may be required to file an annual T3 trust return. This is the case even though the income/expenses should already be reported by the property’s beneficial owners in their income returns.
2. Partnerships: At law, a partnership is not considered a legal entity separate from its partners and generally cannot hold title or a registered interest in its name. As such, the general partner typically holds legal title to land in a bare trust arrangement. The partners’ income is already reported, and beneficial owners (being the partners) are disclosed on the T5013 information return.
3. Real Estate: It is common in real estate investments for a nominee corporation to hold the legal title of the property in trust for the beneficial owner for commercial reasons.
4. Co-signing a mortgage for a family member: For example, co-signing for a child’s mortgage so that they can qualify for a mortgage to get into the housing market.
5. Being named to aging parents’ bank account: It is common to have adult children being named to their aging parents’ bank accounts to make it easier to facilitate transactions.
6. Shareholder Registries: Shareholder registries may not always be accurate, as there may be a delay in obtaining up-to-date shareholder information. When dividends are paid, amounts not received by shareholders due to incorrect information are held in trust until they can be corrected. Furthermore, corporations may be required to hold funds from dividends in trust for lengthy periods to the extent that the correct recipient cannot be readily identified.
7. Internal Administrative Arrangements: Many internal administrative arrangements may create bare trust relationships. For example, it is common for companies to centralize treasury and banking functions with one entity in a group. Funds may be received or disbursed on behalf of other entities in the group, with funds temporarily held in trust through this process. The tax consequences of the underlying transactions are reported on the tax returns (T2, T5013, etc.) of the relevant entity.

It is crucial to determine the level at which a bare trust arrangement is constituted once it has been identified. For instance, if there are several assets with distinct beneficial ownership in a joint venture, it becomes necessary to establish whether the bare trust exists at the joint venture level or the individual asset level. Another example is when you are named on your parent’s bank and investment accounts, and there are multiple accounts. The question arises of how many trust returns you need to file. Would you file one at the bare trust level or file for each account level, which could mean filing multiple returns? The CRA has yet to give guidance on this matter.

In Trust for Accounts Likely Considered Bare Trusts

Financial accounts held “in trust for” another individual are likely bare trust arrangements. These also have similar concerns that have yet to be answered. For example, suppose a bare trustee holds the legal title of several investments within one account; it is still being determined whether there is only one bare trust at the investment level or multiple bare trusts for each investment.

All Trusts Need to Complete Sch 15

Generally, all trusts that are required to file a T3 Return will be required to file Schedule 15.

Schedule 15 asks for information on all trustees, settlors, beneficiaries and controlling persons (i.e., persons who have the ability, through the terms of the trust or a related agreement, to exert influence over trustee decisions regarding the appointment of income or capital of the trust) for the trust (collectively referred to as “reportable entities“).

For each reportable entity of the trust, the following information must be provided:

• name
• address
• date of birth (if applicable)
• country of residence, and
• Tax Identification Number (i.e., Social Insurance Number, Business Number, Trust Number, or, in the case of a non-resident trust, the identification number assigned by a foreign jurisdiction)

In addition, if the above information cannot be provided because the beneficiary is unknown at the time of filing the T3 Return and Schedule 15 (for example, unborn children and grandchildren, their spouses), information must be provided on Schedule 15 under Part C detailing the terms of the trust that extend the class of beneficiaries to unknown entities.

Chapter 2: Significant Penalties

The penalty will equal $25 for each day of delinquency, with a minimum penalty of $100 and a maximum penalty of $2,500.

If a failure to file the return was made knowingly or due to gross negligence, an additional penalty will apply. The additional penalty will equal 5% of the maximum value of property held during the relevant year by the trust, with a minimum penalty of $2,500. Also, existing penalties for the T3 return will continue to apply.

Relief for Bare Trusts for the 2023 Tax Year

The CRA will relieve bare trusts by waiving the penalty payable under subsection 162(7) for the 2023 tax year in situations where the T3 Return and Schedule 15 are filed after the filing deadline. For the 2023 tax year, where the trust’s tax year ends on December 31, 2023, the filing deadline of March 30, 2024, is extended to April 2, 2024, the first business day after the deadline.

This proactive relief is for bare trusts only and only for the 2023 tax year.

However, a different penalty may apply if the failure to file the T3 Return and Schedule 15 for the 2023 tax year was made knowingly or due to gross negligence. This penalty will be equal to the greater of $2,500 and 5% of the highest amount at any time in the year of the fair market value of all the property held by the trust.

Bare trusts did not have an obligation in years before the 2023 tax year to file a T3 Return, and the CRA recognizes that the 2023 tax year will be the first time bare trusts will be required to file a T3 Return, including the new Schedule 15.

As some bare trusts may be uncertain about the new requirements, the CRA is adopting an education-first approach to compliance and providing proactive relief by waiving the penalty under subsection 162(7) for the 2023 tax year in situations where the T3 Return and Schedule 15 are filed after the filing deadline.

Chapter 3: How to Prepare a Nil Trust Return for Bare Trusts

Case Study

• Green Inc. and Blue Inc. have agreed to work together to develop, manage, and lease a specific piece of land.
• To make this happen, Orange Inc. has been chosen to hold the legal title to the land as the Bare Trustee for Green Inc. and Blue Inc., who are the beneficiaries.
• Orange Inc. has accepted this responsibility and will fulfill its duty as outlined in the agreement dated February 1, 2023. All are residents of Ontario for tax purposes.
• John Doe is the director of all three companies.

Step 1: Register for a Trust Number

You can apply for a trust account number online. You can do this by logging into the CRA online account of the Trustee.

A trustee can apply for a trust account number. You need to know your:

• trust name (see below for guidance on naming conventions for bare trusts)
• contact information
• type of trust.

You must also provide a signed copy of the trust document or agreement.

In our case study, Orange Inc. will log into its My Business Account from the “More Services” menu to select Trust account registration.

The questions should be intuitive for simple bare trust arrangements. Please see below for guidance on the naming conventions for a bare trust.

Step 2: Download the PDF Trust Return

You can download a copy of the T3 return and the elated schedules on CRA’s website. Links to the 2023 trust return and schedules are below: T3RET T3 Trust Income Tax and Information Return – Canada.ca

You can find the schedules on the following website: Forms listed by number – CRA – Canada.ca

You can download Schedule 15, the new schedule used to disclose information about the trust and its trustees, settlors, and beneficiaries can be found here: T3SCH15 Beneficial Ownership Information of a Trust – Canada.ca

Step 3: Prepare the T3 Return

Complete the Identification and other information.

Trust account number

Enter the trust account number you obtained online.

Fiscal period

In most cases, it should be January 1, 202X, to December 31, 202X.

Name of Trust

When a bare trust has yet to be named, here are some guidelines CRA provides for naming a bare trust.

If there is a written trust deed or other agreement governing the bare trust and the document identifies a name for the bare trust, you can enter it in the name field.

If there is no written trust deed or other agreement governing the bare trust or if the document does not identify a name for the bare trust, list the legal name (e.g., the entire corporate name identified in the articles of incorporation, or the first and last names for an individual) of the beneficial owner(s) with the word “Trust” at the end.

For example, if “Ms. Andrews” is the beneficiary of the bare trust and there is no identified name for the trust, you could list “Ms. Andrews trust” in the name field.  If there is more than one beneficial owner, place the names alphabetically based on the last name with the word “Trust” at the end.

When using our online services, the name field is limited to 60 characters; if the name(s) exceed(s) the 60-character limit, you can stop typing when the limit is reached but include the word “trust.”

In our case study, the name of the Bare Trust should be “Blue Inc. Green Inc. Trust.”

Residence of the Trust

Choose the residence of the trustees, including the province. In our case study, it is Ontario.

Trustee Information

Enter the information about the Trustee who is the CRA’s primary contact. If the trustee is a corporation, please enter the corporation’s contact person, such as a director or an officer of the corporation.

Trust Information

Enter information about the trust.

If all your trustees and beneficiaries are Canadian residents, then most likely, the trust will not be a Deemed resident trust.

Type of Trust

Enter the Bare Trust (code 307) for the “type of trust.”

Also, enter the Date that the trust was created.

Information about the return

Enter information about the return.

If this is your first filing ever, which is likely the case for most Bare Trusts in 2023, please select Yes, as noted below.

You must also provide your trust agreement (i.e., trust document) to the CRA when you apply for a trust number. See above for more details. If you did not upload your trust agreement when you opened your trust account numbers, you can upload it later using the following link.

Reporting foreign income and property

Answer the following required questions.

Certification & Signatures

Complete the certification and sign at the bottom of the return. E-signatures are acceptable.

Calculating total income

Since the Bare Trust only holds legal tile, it generally should not have any income. Therefore, you should not need to enter anything in the following sections:  “Calculating total income,” “Calculating net income,” “Calculating taxable income,” and “Summary of tax and credits” (steps 2 to 5).

Step 4: Completing Schedule 15

As noted, for tax years ending on or after December 31, 2023, a trust (including a bare trust) required to file a T3 return, other than a listed trust, generally must report beneficial ownership information on Schedule 15.

Trusts must report the identity of all trustees, settlors, beneficiaries, and controlling persons (collectively called “reportable entities”) on Schedule 15. It is necessary to include information for all reportable entities of the trust that existed at any time during the tax year, even if the person became a reportable entity at any time during the tax year or is no longer a reportable entity of the trust at the end of the tax year for which a T3 return is being filed.

Please note that if you are submitting beneficial ownership information for your T3 return, it must be done using Schedule 15. Please be aware that alternative methods such as spreadsheets, PDFs, or XML files will not be accepted. If you are filing the T3 return by paper, Schedule 15 must be used, and in case you need multiple copies of Part B of Schedule 15, you can mail them along with the T3 Return. The fillable PDF version of Schedule 15 includes additional Part B sections if required.                                             

Enter the Year

First, enter the tax year. In our case study, we are working on the 2023 tax year.

Part A – Annual beneficial ownership information

If this is the first time completing Schedule 15,  answer as follows:

Part B – Identification of reportable entities and Reportable Entity Type

You will complete Part B for the following:

• Settlors
• Trustees
• Beneficiaries
• Controlling persons 

Identifying Settlors

The term “settlor” generally refers to a person who has provided a loan or transferred property, directly or indirectly, to a trust for its benefit. However, exceptions apply, including situations where the person or partnership has engaged in arm’s length transactions with the trust, such as providing a loan at a reasonable interest rate or making a transfer for fair market value consideration.

In our case, the settlors would be Blue Inc. and Green Inc., the parties that transferred the initial funds to purchase the land.

Identifying Trustees

 Trustees hold legal title to property in trust for the benefit of the trust beneficiaries. The trustee includes an executor, administrator, assignee, receiver, or liquidator who owns or controls property for some other person.

Identifying Beneficiaries

A “beneficiary” of a trust is generally a person (other than a protector) who has a right to compel the trustee to properly enforce the terms of the trust, regardless of whether that person’s right to any of the income or capital is immediate, future, contingent, absolute or conditional on the exercise of discretion by any person.

The requirement to provide the necessary information in respect of beneficiaries of a trust on Schedule 15 will be met if the required information is provided in respect of each beneficiary of the trust whose identity is known or ascertainable with reasonable effort by the person making the return at the time of filing the return. Suppose a beneficiary’s identity is known or ascertainable; complete Part B of Schedule 15. Suppose a beneficiary’s identity is not known or ascertainable with reasonable effort. In that case, the person making the return must provide sufficiently detailed information to determine with certainty whether any particular person is a beneficiary of the trust. In this case, complete Part C of Schedule 15.

Identifying Controlling Persons

For the trust reporting requirements, the term controlling person means a person who has the ability (through the terms of the trust or a related agreement) to exert influence over trustee decisions regarding the appointment of income or capital of the trust. This would include, for example, a protector of the trust.

See the attached Schedule 15 for guidance on applying it to our case study.

Helpful Sources

[1] Subsection 150(1.3) of the Income Tax Act (the “Act”).

[2] Tax Executives Institute (TEI) Commentary, 2023-09-27 — Bare Trust Reporting Rules – 2023-09-27

The post Preparing Trust Returns (T3) for Bare Trusts appeared first on LRK Tax LLP.

• Increase Generational Wealth Through Unique Tax Planning During Recession – Despite the possibility of a recession or sluggish economic growth in 2023, there are ways for entrepreneurs and small business owners to leverage the tax system and boost their long-term financial security. These tax planning opportunities can help them accumulate generational wealth.
  
• Flip the Anti-Flipping Tax on its Head – The government introduced the anti-flipping tax to discourage short-term residential home flips. However, through clever tax planning, taxpayers can use this rule to pay less taxes by structuring real-estate investments through a corporation.  
  
• Non-Residents Getting Out of Canadian Real Estate Need to Pay Attention to Special Tax Filings  – The implementation of policies such as the Underused Housing Tax (UHT) has prompted foreigners to sell their Canadian properties. Failing to engage in effective tax planning prior to selling could result in unexpected financial strain and funds being held by the CRA.

If you found this newsletter useful, please feel free to pass it on to your team of advisors as it will be useful for them as they also consider your financial, estate, and business plan to preserve and grow your hard-earned wealth. 

Sincerely,
LRK Tax Team

The post <strong>February 2023 Newsletter</strong> appeared first on LRK Tax LLP.

Trustees Need to file a UHT Return

If you’re a trustee, there’s no escaping the requirement to file a UHT return*. Failure to do so could result in hefty penalties, with a minimum of $5,000 per year for each trustee. That’s right, each trustee! So, if there are two to three trustees involved, the penalty could easily add up to $10,000-$15,000 per year. And, if the trust only has real estate and no cash to pay the penalty, it could lead to further issues.

*Note, there are exemptions for trustees acting as personal representatives for a deceased individual.

UHT Taxes Owing for Trustees

Trustees who are residents of Canada and have all Canadian resident beneficiaries generally don’t have to pay tax. But, if a beneficiary leaves Canada during the existence of the trust, the trustee could be exposed to paying tax. This could be a headache, especially if the trust only has real estate and doesn’t have the assets to pay the tax.

UHT Tax Planning for Trusts with Non-Resident Beneficiaries

But don’t worry. There are remedies that trustees can use to avoid the UHT. As long as the trust has no non-resident beneficiaries on December 31st of each year, the trustee won’t be liable for the tax. If a beneficiary does leave Canada, the trustee could use a tax-efficient technique to remove the non-resident beneficiary’s interest in the trust.

Conclusion

In conclusion, being a resident of Canada doesn’t necessarily exempt you from the UHT rules. Trustees must be aware of their responsibilities and potential liabilities. They should explore the available remedies to avoid any penalties and tax implications.

If you need consultation on whether you are liable for the UHT, feel free to give us a shout. You can check out our resources on the UHT by clicking here.

The post Trustees: Don’t Fall into the Underused Housing Tax Trap! appeared first on LRK Tax LLP.