Who’s really impacted by closing the capital gains loophole?

There’s a lot of fear-mongering about who’s going to be impacted by the changes to capital gains taxation. Let’s break down who benefits most from capital gains and who will pay more under the new rules that went into effect on June 25.

Capital gains taxes have two components: capital gains taxes paid by individuals and capital gains paid by corporations. Up until June 25, 2024, only 50% of capital gains for both individuals and corporations were subject to taxation; in contrast, 100% of workers’ incomes are subject to taxation. 

According to income tax data, the top 1.5% of income earners had over $93 billion in capital gains in 2021, only half of which was subject to tax. Capital gains made up about a third of the total income for these top earners. In contrast, only 2% of incomes for people making under $100,000 come from capital gains. As shown in Table 1, the wealthiest 1.5% of Canadians collected 61.2% of personal capital gains in 2021. In other words, more than 60% of the tax benefit from the capital gains loophole went to people making over a quarter million dollars a year. 

Table 1. Personal capital gains by income group, 2021

^{Source: CRA T1 Final Statistics Table 2}

For individuals, nothing has changed for capital gains under $250,000 each year. Half of that will remain untaxed. However, under the new rules, two-thirds of any capital gains over $250,000 will now be subject to income tax. One-third remains untaxed, even for the 0.13% of Canadians who have taxable capital gains over $250,000 each year. It’s important to remember that not so long ago, 75% of capital gains were included in taxable income, so the new changes maintain a significant tax break for the wealthiest Canadians.

Some individuals who don’t receive a quarter million dollars every year will occasionally realize significant capital gains. Often-stated examples include selling a small business or passing on a second property in retirement. These cases are in the minority, and there are options to lessen the tax blow in these cases - including the lifetime capital gains exemption for small business owners, splitting the capital gain between spouses, and using a capital gains reserve.

Some small business owners have expressed concerns about the changes to the capital gains inclusion rate. In Table 2, we show how two illustrative small business owners would be affected by these changes, compared to how one of the largest Canadian corporations would be affected.

Table 2. Impact of changes to capital gains taxation on various businesses (values in $M).

Farms and small business owners

Small business owners will typically only face capital gains taxes upon the sale of their business. We assume they sell the business as an individual rather than within a company.  Let’s consider someone who has owned a farm in Ontario of median size (about 115 acres) since 1996 and has otherwise not experienced capital gains. Based on the average cost of farmland per acre, the farmer would earn a $2,030,325 capital gain if they sold at 2023 prices. Because of the increase in the lifetime capital gains exemption, this individual would actually pay less in capital gains taxes after the reform than they did before. This calculation doesn’t even take into account that the portion of the farm on which the farmer lives is considered a principal residence. The gain on this portion of the property would not be subject to taxation at all. 

To address concerns about succession planning for large family farms that may see an increase in capital gains taxes, targeted policies could be introduced to support passing on farms to the next generation. Relying on the capital gains loophole for this purpose is a poorly targeted measure that provides much larger benefits to large corporations, as we’ll see below.

Looking at the sale of a larger small business, like a tech startup owned by spouses, the increase in taxes would be relatively small compared to the size of the capital gain. With a $6 million capital gain received by spouses with access to the lifetime capital gains exemption, the sellers would still take home over $4.8 million after the reform. That’s enough for both owners to live at the average income in Canada for 42 years. The owners would still realize tax savings of over $2 million compared to if this income was fully taxable employment income. For this example, we’ve assumed the business is sold in 2025, making it eligible for a one-third inclusion rate on the first $200,000 in capital gains (after the lifetime exemption is deducted) under the Canadian Entrepreneurs’ Incentive (CEI). By 2034, the value eligible for the CEI will be increased to $2 million, in which case the owners will pay less taxes compared to before the reform.

On the other hand, large corporations will be significantly impacted by this tax change. The capital gains loophole used by corporations cost the federal government $16.8 billion in 2021. As an example of the impact the recent policy change will have on large corporations, let’s take a look at Canadian National Railway (CNR; the firm with the 4^th largest market capitalization of Canadian corporations). According to their public 2023 annual report, CNR sold a property in Markham and Richmond Hill for a capital gain of $129 million on December 10, 2023. The firm reports that it paid about $17 million in tax on this property, in line with the expected effective tax rate of 13.2% on capital gains (half of the statutory corporate income tax rate in Ontario). If this transaction was realized after June 25, 2024, the company would have paid $22.8 million in taxes, an effective tax rate of 17.7%. Because this is a large firm paying corporate income tax rather than personal income tax, they don’t have access to the $250,000 exemption or the lifetime capital gains exemption.

Sales of real estate like the one made by CNR are responsible for a significant share of corporate capital gains. Figure 1 below shows capital gains by sector in 2021. Capital gains are earned disproportionately by corporations in the finance, insurance, and real estate sectors. Finance and insurance earned $24.6 billion in capital gains, followed by real estate, rental and leasing at $22.3 billion. Significant capital gains are only rarely earned by corporations directly involved in new productive investment. Instead, corporate capital gains largely go to financial middlemen and corporate landlords engaging in real estate speculation. The changes to capital gains taxation will impact large corporations involved in speculation and their wealthy shareholders more than anyone else.

Figure 1. Corporate book capital gains by sector, 2021

^{Note: Sectors are based on 2-digit NAICS codes. Book capital gains may differ from capital gains assessed for tax purposes because corporations may use different accounting procedures from the CRA.}

Sign here to send a message to Ottawa to close the capital gains loophole, now!