Navigating the changes: How Federal Budget 2024 affects Canadians' taxes

April 19, 2024

Budget 2024 was released on April 16, 2024, and it contained several proposed changes to Canada's tax system. Over the next several days, Dentons Canada's Tax group will release several short pieces that highlight the changes and how they may impact certain Canadians.

When it comes to Canada's entrepreneurs and especially high growth tech companies, Budget 2024 offers a mixed bag of burdens and benefits. Key highlights of the new tax proposals are:

• To increase the inclusion rate for capital gains on corporations and trusts as well as capital gains beyond $250,000 for individuals to 66.67% from 50%. These changes will also carry over to the effective taxation rate on employee stock options and will be effective on gains realized on or after June 25, 2024;
• To increase the lifetime capital gains exemption for dispositions of qualified small business corporation shares to $1.25 million for dispositions that occur on or after June 25, 2024;
• Commencing January 1, 2025, and phased in over 10 years in increments of $200,000, to create a new Canadian Entrepreneurs' Incentive which will reduce the inclusion rate to 25% on the first $250,000 of eligible capital gains and 33.3% for eligible capital gains beyond $250,000 on a lifetime maximum of $2 million in eligible capital gains in certain circumstances further described below; and
• To permit immediate expensing to businesses that acquire certain "innovation-enabling and productivity enhancing" assets (being patents, data network infrastructure and general-purpose electronic data-processing equipment) between now and January 1, 2027.

The first of these changes, the increase to the inclusion rate for the taxation of capital gains, is already attracting attention because it may detract entrepreneurs and start-up founders from creating businesses in Canada by layering on additional tax on a potential exit. This proposal also runs contrary to a fundamental characteristic of Canada's tax system, which has always been integration, being that one should be indifferent in whether to invest as an individual or via a corporation. By not providing the same $250,000 limit to corporations, this proposal increases the effective tax rate to an individual who may have chosen to invest through a corporation at a time when integration was respected, prior to this proposal being introduced. Budget 2024 also did not mention any indexing for this $250,000 limit, which may feel painfully low in future years.

Budget 2024 attempted to offset the pains associated with the new capital gains inclusion rate by enhancing some of the tax benefits entrepreneurs may obtain on a sale of their corporation. Budget 2024 proposes to increase the amount on which certain shareholders can claim for their lifetime capital gains exemption to $1.25 million with indexing to increase this amount in future years. Budget 2024 also introduced a new Canadian Entrepreneurs' Incentive which may reduce the capital gains inclusion rate on the next $2 million for certain gains. The description of this new Canadian Entrepreneurs' Incentive resembles the lifetime capital gains exemption in some respects but includes additional requirements that the individual claiming the benefit (a) be a founding investor at the time the corporation was initially capitalized, (b) at all times having owned more than 10% of the outstanding shares (both votes and value), (c) having owned the shares for a minimum of five years prior to disposition, and (d) being actively engaged on a regular basis in the activities of the business. In addition the proposal seeks to exclude professional corporations, corporations in the financial, insurance, real estate, food and accommodation, arts, recreation or entertainment sectors, and corporations providing consulting or professional care services. Finally, in order to be eligible the share must have been obtained for fair market value consideration. The legislation supporting this new proposal has not been released but those details will be important to understand how and when this incentive may actually apply.

Finally, Budget 2024 also provides for immediate expensing, through a 100% CCA rate on the purchase of "innovation-enabling and productivity enhancing" assets. This incentive could be an enticing benefit for certain mature companies to motivate them to make capital investments over the next three years while they can obtain this immediate expense. However, providing additional deductions to start up companies, which are often not generating taxable income, may not be as motivating.

In addition to the foregoing tax considerations, Budget 2024 also proposes specific investments in technologies, incentives, and supports for Canada's tech and artificial intelligence (AI) ecosystem, which may provide several benefits for Canadian SMEs and tech companies. These investments will be distributed over the next four to five years and include:

• $2 billion to be allocated to initiate the AI Compute Access Fund and Canadian AI Sovereign Compute Strategy. These initiatives aim to facilitate access to computational resources essential for Canadian researchers, start-ups, and scaling businesses to bolster the development of domestically owned AI infrastructure.
• $200 million to be disbursed through Canada's Regional Development Agencies to bolster AI start-ups. This funding will empower these ventures to introduce novel technologies to the market and expedite the adoption of AI across critical sectors such as agriculture, clean technology, health care, and manufacturing.
• $100 million to be allocated to the National Research Council's AI Assist Program. This initiative is designed to aid Canadian small- and medium-sized enterprises (SMEs) and innovators in developing and implementing new AI solutions. Furthermore, Budget 2024 proposes to provide $14.5 million to Innovation, Science and Economic Development Canada for the Innovation Asset Collective which will support small and medium-sized clean tech businesses with specialized intellectual property support to grow their businesses.

The Federal Government is hopeful that AI research, development and deployment stand to spur significant economic growth, and that Canada is uniquely positioned to seize these opportunities. Consequently, the investments proposed in Budget 2024 are intended to foster innovation, drive productivity gains, and increase collaboration between industry and academia with the goal of positioning Canada as a global leader in AI. In light of a budget landscape that presents a varied mix of challenges and advantages, it is hoped that these strategic investments in technology and AI will serve as a compelling incentive for companies to choose Canada as their preferred destination for operation and innovation.

If nothing else, the proposals contained in Budget 2024 as they apply to entrepreneurs and high growth, tech companies, add another layer of complexity and planning opportunities. If you have any questions on how these may apply to your situation please contact a member of Dentons Canada's Tax group.