Canadian Government Defers Capital Gains Inclusion Rate to January 1, 2026
The newly appointed Minister of Finance, successor to Minister Freeland, Dominic LeBlanc recently announced an amendment to the legislative changes that has not yet made its way into parliament. The proposed legislation that would enact the previously announced changes to the capital gains inclusion rate (i.e., the portion you pay taxes on) will now be retroactive to January 1, 2026, a substantial departure from the original effective date of June 25, 2024.
Taxpayers may question if this decision actually provides tax relief? The short answer is simply, no, it does not.
Retroactive tax planning is prohibited
In the immediate aftermath of the announced increase to the capital gains rate a brigade of tax professionals and their respective clients held emergency, late-night, conference and video calls to determine whether to trigger accrued capital gains before the rate increase. If you were one of those individuals who planned and implemented a reorganization of their corporate structure, or otherwise disposed of property held in a family trust, or family cottage, to ensure your existing capital gains would be taxed at the lower rates exclusively, you are probably now wondering if this can be undone or unreported to avoid paying the tax you intentionally triggered due to the announced change.
The simple answer is no, generally speaking, retroactive tax planning is not permissible under the law in Canada. This has been confirmed by very high-profile cases in the recent past.
Rectification & Recission: Juliar & Fairmont Hotels
Two ways taxpayers have, in the past, sought to use to achieve preferential tax outcomes are the contractual and equitable remedies of ‘rectification’ and ‘recission’.
In short, ‘rectification’ is exactly as it sounds. It provides the remedy to correct or cure errors or mistakes, such as where a contract document(s) have misstated the verbal agreement the documents are meant to reflect, or even something as simple as clerical errors and typos should they be in respect of material items such as the price to be paid. The objective of this remedy is to put parties or counter-parties in the position that they would be but for the errors, mistakes, or omissions.
Taxpayers have, in the past, argued (mostly unsuccessfully) that rectification ought to be applied to allow for more favourable tax outcomes than what was assessed by the CRA. In other words, taxpayers and their very clever lawyers have made some version of the argument ‘you assessed my transactions in the way they appear, but what we really meant to do was something else so you should assess my tax as if I had done that something’.
The second remedy typically sought is ‘recission’. This remedy is what anyone experiencing buyer’s remorse is hoping for. The remedy simply attempts to undo the transactions or events that have occurred, with the objective of putting parties back to their position as they were prior to entering into or performing an agreement. It is rare for this remedy to be available as often it is simply not possible.
These two remedies are not granted by the CRA or the Tax Court of Canada, as they do not have the jurisdiction or authority for granting such remedies. Rather, they are granted by the Courts with appropriate jurisdiction to hear disputes related to the actual transactions themselves.
When these remedies are granted, the tax implications may be favourable and as consequence they can create a backdoor to retroactive tax planning. For this reason, the CRA highly scrutinizes these claims by taxpayers.
Most recently, the Supreme Court of Canada’s 2016 decision in Canada (Attorney General) v. Fairmont Hotels Inc., sought to clarify the circumstances where rectification is available to a taxpayer to cure an unintended tax outcome. In short, this case provided a narrower legal test than the existing precedent (Juliar v Canada (Attorney General), 1999) which merely called for a common and continuing intention [to transact without creating a tax liability].
In short, the remedy (and favourable tax consequences) will only be available where the error to be cured is in respect of the transaction itself and is not available where an intentional transaction produces unintentional tax outcomes.
What Can Be Done?
If you’re in the position where you undertook a reorganization, but have yet to run into your filing deadline, it will be worthwhile to determine what if anything remains to be done to minimize or defer tax for the year.
For example, if your reorganization involved a section 85 rollover, the transaction is deemed to have occurred at the ‘elected amount’ not at the fair market value. In other words, the realized and unrealized (for tax purposes) are within the control of the taxpayer.
The CRA’s position, per their Information Circular IC 76-19R3, on when the elected amount must be determined is that once you have filed the election you may only amend the elected amount for the purposes of correcting an error, omission, or oversight which otherwise would produce unintended tax consequences to the taxpayer. Amending the elected amount for the purposes of retroactive tax planning will not be accepted by the CRA. Likewise, amending the elected amount to ‘take advantage of amendments in the law enacted after the original election was filed’ will not be accepted by the CRA.
It is also possible to late-file an election under section 85, up to three years after the initial transaction. This is not considered to be ‘retroactive planning’ because the nature of an ‘election’ under the Act is that it is a discretionary choice of the Taxpayer’s to make.
However, if you did not rely on section 85 in the course of your reorganization, you need to closely look at the other provisions in the subdivision of the Act which deals with transactions involved shareholders and their respective corporations.
Two very similar provisions exist in the Income Tax Act, which allow for exchanges of capital claims against corporations (share or debt instruments) to be treated on a ‘rollover’ basis: Sections 51 & 86. Each of these provisions are designed to allow shareholders or debt holders (under particular circumstances) to exchange their current capital property with the corporation, for newly issued shares or debt instruments by the corporation, without requiring tax to be paid on the unrealized accrued gains.
Section 51 differs in one very important aspect: it deems the transaction to not be considered a ‘disposition’ for the purposes of the Act. By deeming the transaction to not have been a disposition the event is not reportable in your return for the year in which it occurred.
Section 86 is deemed to be a disposition where the proceeds of disposition are the initial cost amount of the exchanged shares. A transaction that falls under this provision is reportable.
Next Steps
The obvious next step for anyone who wants to revisit how this new announcement will impact their reorganizational planning last June is to set up a meeting with their tax advisors before the filing deadline. Your specific situation is unique and should be treated as such.
***Disclaimer: This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions, you should consult a lawyer.
Stephen Mather
