— July 4, 2024 —
In our second post on the Federal Government’s Notice of Ways and Means Motion, released on June 10, 2024, we turn our focus to a significant change affecting youth taxable capital gains.
One of the notable changes introduced in Budget 2024 pertains to the treatment of taxable capital gains for individuals under 17 years of age. These changes are designed to address and prevent tax avoidance through non-arm’s length transactions involving minors. The new rules can be found under the amended sections of the Income Tax Act.
New Provisions:
- Deemed Taxable Dividends for Non-Arm’s Length Transactions:
– New: ITA ss. 120.4(4)
– New Rule: If a specified individual under the age of 17 would have a taxable capital gain from the disposition of shares (excluding shares listed on a designated stock exchange or shares of a mutual fund corporation) that are transferred to a non-arm’s length person, this gain is deemed not to be a taxable capital gain. Instead, 1.5 times the amount is deemed to be received as a taxable dividend that is not an eligible dividend.
- Inclusion of Trust Income:
– New: ITA ss. 120.4(5)
– New Rule: If a specified individual under 17 years of age is required under subsections 104(13) or 105(2) to include an amount in computing their income, and this amount is attributable to a taxable capital gain of a trust from a disposition of shares transferred to a non-arm’s length person, subsections 104(13) and 105(2) do not apply. Instead, 1.5 times the amount is deemed to be received as a taxable dividend that is not an eligible dividend.
These amendments specifically target transactions involving minors, ensuring that capital gains from non-arm’s length transactions are appropriately taxed as dividends, thereby closing a potential loophole for tax avoidance.
Scenario: Youth Taxable Capital Gains and Deemed Dividends
To illustrate these changes, let’s consider a practical scenario involving Alex, a 16-year-old, who receives shares in a private company from his father.
Scenario Details:
– Background:
– Alex receives shares not listed on a designated stock exchange from his father.
– The fair market value (FMV) of the shares at the time of transfer is $150,000.
– Alex later sells these shares for $180,000, realizing a capital gain.
– Calculation Before New Rules:
- Capital Gain: $180,000 (sale price) – $150,000 (FMV at transfer) = $30,000
- Taxable Capital Gain: $30,000 × 50% inclusion rate = $15,000
– Impact of New Rules:
Under the new rules, because Alex is under 17 and the shares were transferred to him through a non-arm’s length transaction, the $30,000 gain is treated as a deemed taxable dividend instead of a capital gain.
- Deemed Taxable Dividend: $30,000 × 1.5 = $45,000
This $45,000 deemed dividend is not an eligible dividend and will be taxed at Alex’s marginal tax rate for dividends, which is typically higher than the rate for capital gains.
Illustration with Trust Income
Suppose the shares are held in a trust for Alex, and the trust realizes the capital gain from selling the shares.
– Calculation Before New Rules:
- Capital Gain: $30,000 (trust’s capital gain)
- Taxable Capital Gain for Alex: $30,000 × 50% inclusion rate = $15,000
– Impact of New Rules:
Instead of Alex including $15,000 as a taxable capital gain in his income, the amount is treated as a deemed taxable dividend.
- Deemed Taxable Dividend: $30,000 × 1.5 = $45,000
Again, this $45,000 deemed dividend will be taxed at a higher rate than the capital gain would have been.
Conclusion
By converting the $30,000 capital gain into a $45,000 deemed taxable dividend, the new rules ensure that non-arm’s length transactions involving minors are more heavily taxed, thereby reducing the incentive for using such transactions to minimize tax liability.
Stay Informed with AJAG
Were you aware of these proposed legislative changes before reading them here? At AJAG, we are dedicated to delivering professional development updates as soon as they become available, ensuring you can assess the impact and make both your staff and clients aware of what is coming and its professional and financial implications. These updates underscore the critical need for tax practitioners to stay informed about changes to the Income Tax Act. Reviewing these amendments carefully will enable you to provide accurate advice and ensure your clients remain compliant with the new regulations.
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