Canada's significant changes to alternative minimum tax will affect taxpayers in 2024

Proposed amendments to the alternative minimum tax (AMT) regime for high-income individuals and certain trusts were introduced in the 2023 federal budget, effective for tax years beginning after 2023. The proposed amendments may have a significant impact on the tax liability of high-income individuals, including those benefitting from significant employee stock option benefits. Draft legislative proposals to implement these changes were released during the summer (2023) for public comment; however, the government has yet to release revised draft legislative proposals with respect to these amendments.

Executive summary

This Tax Alert provides an overview of key proposed amendments to the alternative minimum tax (AMT) calculation for individuals, discusses how the amendments may impact certain high-income individuals, and analyzes AMT exposure under the proposed regime.

Proposed amendments to the AMT regime for high-income individuals were introduced in the 2023 federal budget, effective for tax years beginning after 2023. On 4 August 2023, draft legislative proposals to implement these changes were released and, during the consultation period, stakeholders identified various concerns with respect to certain amendments. The draft legislative proposals apparently remain under development, a they were not included in Bill C-59, Fall Economic Statement Implementation Act, 2023, which was tabled on 30 November 2023.¹ To date, the government has not provided additional information about the amendments or whether any comments received during the consultation period will be incorporated into subsequent draft legislative proposals.

Broadly speaking, the proposed amendments expand the AMT base by further limiting tax preference items, increase the basic exemption amount and the AMT rate, and extend eligibility for the general AMT exemption to additional types of trusts.

The federal government estimates that these amendments will generate an estimated CA$3.0b in additional revenues over five years.

Background

AMT was originally implemented in 1986 to target high-income individuals by levying a basic income tax based on a simplified computation of taxable income. More specifically, the minimum tax is designed to ensure that individuals, including certain trusts, with high gross income, who would otherwise pay little or no income tax because they have a significant number of tax-preference items, pay at least a minimum amount of tax for the year. Tax preferences are specific items that reduce taxable income or tax payable, such as the capital gains exemption or the tax credit for political donations.

No significant reforms have been made to the AMT regime since its implementation. Currently, the government estimates that thousands of wealthy Canadians pay comparatively little income tax by making use of deductions and tax credits.

The AMT computation requires a parallel calculation to the regular income tax calculation that allows fewer deductions and exemptions to arrive at adjusted taxable income. The basic exemption amount, which is CA$40k under the current regime, is then deducted from adjusted taxable income, and the balance is multiplied by a flat federal minimum tax rate (currently 15%), which generates the AMT amount. Certain nonrefundable tax credits may be deducted from this amount. An individual's final tax liability is the greater of the AMT amount and the regular income tax calculation.

AMT paid in one tax year may be carried forward for up to seven years to reduce regular tax payable in a subsequent year, but only to the extent AMT in that subsequent year is less than regular tax payable. Thus, this arrangement generally creates a prepayment of tax through the AMT regime rather than a permanent additional tax.

Proposed changes

The proposed legislative amendments are intended to target high-income individuals by:

• Increasing the basic AMT exemption amount from CA$40k to the amount that corresponds to the lower threshold of the fourth federal income tax bracket, which is indexed annually to inflation and will be CA$173,205 in 2024. This basic exemption will be available to individuals and certain trusts.²
• Increasing the flat federal minimum tax rate from 15% to 20.5%.
• Broadening the AMT base to include additional income items and limiting certain deductions and credits. Some notable amendments include:

(i) Including eligible charitable donations, interest and carrying charges incurred to earn property income or incurred on spousal loans, Canada Pension Plan contributions, moving expenses, and childcare expenses.

Although no changes have been made to provincial AMT rules, provincial AMT is generally calculated by multiplying federal AMT by a prescribed provincial rate. As a result, provincial AMT will indirectly increase in 2024 and later years.

For additional information on the proposed legislative amendments and their impact on individuals, refer to the October 2023 edition of TaxMatters@EY: Family Wealth Edition.

Proposed amendments' impact on high-income individuals — selected issues

The goal of the proposed amendments is to ensure that high-income individuals pay a share of tax proportionate to their income, while removing the application of AMT from most middle-class Canadians. As such, affected individuals must consider the impact of the proposed amendments on their personal income tax returns for 2024 and beyond.

It is important to note that the AMT rules do not apply to corporations, only individuals and certain trusts.

A number of pertinent issues that will impact certain target groups are highlighted below. These target groups may want to carefully review their AMT exposure under the proposed amendments. Although AMT paid may be recoverable during the seven-year carryover period, additional planning may be required to recover the amount paid.

Portfolio investors

Individual investors with significant accrued capital gains may have a higher AMT exposure in 2024 and beyond because the capital gains inclusion rate is increased from 80% to 100% for AMT purposes.

As a comparison of the AMT against the federal income tax rate only, high-income individuals subject to the top federal income tax rate of 33% will have an effective federal income tax rate on capital gains of 16.5%, while the proposed federal AMT rate is 20.5%. Thus, an individual with significant capital gains after 2023 may be subject to a higher tax rate on that income.

For example, assume that an individual subject to the highest income tax rate incurs CA$100 of capital gains in 2024. The following federal tax liability would result, before taking into account other deductions and nonrefundable tax credits:

Therefore, the proposed amendments will result in CA$4 of additional federal tax.

Flow-through shares

Individuals who invest in flow-through shares may experience two separate issues in relation to their investment under the proposed amendments.

1. At the time an investment is made, the income inclusion of the flow-through deduction for AMT purposes will now be subject to the higher proposed AMT rate of 20.5% instead of the current 15% rate. The higher rate may increase the probability that investing in flow-through shares will trigger AMT at the time of investment.
2. At the time that flow-through shares are sold, the capital gain realized by the investor, which may be significant given that the flow-through shares generally have a nominal cost basis, will now be subject to the 100% capital gains inclusion rate under the proposed AMT regime.

Consequently, additional forecasting may be required prior to making a flow-through share investment to assess the impact of the initial income inclusion and the disposition of the shares in light of the individual's projected income, deductions and credits.

Income splitting with family members

Individuals who have entered into prescribed rate loan arrangements with their lower-income spouse (or common-law partner) and/or children or grandchildren may find that the proposed restrictions on the deduction of carrying charges results in an AMT risk. Because the deduction for carrying charges, including interest incurred on funds loaned to a family member, will be limited to 50% of the amount paid, adjusted taxable income for AMT purposes will increase. Meanwhile, the interest income reported by the family member will remain subject to full taxation under both the regular tax and AMT regimes. The impact will be more pronounced for individuals who have entered or are considering entering into these arrangements at higher interest rates.

Consequently, the amendments, combined with the current higher prescribed interest rates and lower portfolio returns, may make these tax planning arrangements less favorable than in the past. For existing loan arrangements, it may be prudent to perform a similar cost/benefit analysis.

Charitable donations

Individuals who have made significant charitable donations may be impacted under the proposed rules because these donations will be subject to a 50% inclusion rate when calculating AMT. As such, these individuals may experience a reduced tax benefit if significant donations are made after 2023.

Individuals who plan to make significant donations may want to consider accelerating their plans to 2023 or spreading out the donations over several years to limit the exposure to AMT. Consult with your advisor to ensure that a tax-efficient outcome is achieved.

Shareholders of Canadian-controlled private corporations

Shareholders of Canadian-controlled private corporations (CCPCs) who are also active in the business have great flexibility in making decisions about their remuneration to pinpoint the optimal allocation between compensation and dividends. Since CCPCs have various tax characteristics that may trigger AMT for shareholders, especially when shares of the company are sold, increasing compensation paid may be beneficial to avoid AMT and reduce the CCPC's taxable income. Though dividends received are unlikely to trigger AMT on their own, they may contribute to the shareholder's AMT liability. This may be a good time to revisit shareholder remuneration planning to minimize the impact of the proposed AMT regime while being mindful of other limitations, such as the tax on split income rules.

Example of the proposed AMT rules

To illustrate some of the proposed amendments, consider the following example (provincial taxes are ignored).

An individual has an unused lifetime capital gains exemption of CA$1m and reports the following items on his 2024 income tax return:

• CA$200k in portfolio capital gains
• CA$50k capital loss carryforwards
• CA$2m capital gain from the sale of QSBC shares
• CA$200k in employee stock option benefits eligible for the one-half stock option deduction
• CA$15k of carrying charges
• CA$35k of charitable donations

Since the AMT liability is greater than the regular federal income tax amount, the individual would owe CA$119,741 (that is, CA$299,403 less CA$179,662) of AMT in 2024 in addition to regular federal tax of CA$179,662.

In the example above, the proposed rules require significantly more cash flow in 2024 to fulfill the individual's tax obligation. While the additional AMT paid may be recoverable during the seven-year carryover period, additional planning may be required to ensure there is sufficient income in the carryover period to recover the AMT paid in respect of the 2024 tax year.

Tax planning considerations

With the new capital gains inclusion rate of 100% for AMT purposes, "capital gain harvesting" could offer one potential strategy to mitigate AMT exposure for individuals and certain trusts. The strategy addresses a fundamental difference in the way taxable income for AMT purposes is calculated. That is, "net gains" realized in the year are subject to a 100% inclusion rate for AMT purposes, but net capital losses carried forward are deducted from income at their "net" inclusion (typically 50%).

Thus, in a year in which an investor incurs substantial capital losses, there may be an advantage to triggering gains to offset the net capital loss to mitigate AMT on those gains in a future year.

To illustrate this, consider the example below where a CA$100 capital loss is recognized in Year 1, but a CA$100 capital gain is realized in Year 2. The capital loss is carried forward to Year 2 where it may be claimed against the capital gain. Under the proposed AMT rules, the entire capital gain in Year 2 is included in taxable income, but only 50% of the capital loss from Year 1 is deductible resulting in CA$50 of taxable income for AMT purposes. If the capital gain was recognized in Year 1 instead, it would be fully offset by the capital loss.

For investors with significant unrealized capital gains or net capital losses from prior years, it may be beneficial to trigger capital gains in 2023, which may be offset by the net capital loss carryforward balance.

Similarly, investors with capital gains reserves may reduce the reserve claimed in 2023 to accelerate gains that may be offset by net capital losses carried forward.

In certain circumstances, another strategy may be to transfer an investor's portfolio to a holding company. Although, there may be a slight cost due to lack of integration in certain provinces, AMT does not apply to corporations.

Consult with your advisor to assess your potential AMT exposure under the proposed rules and whether any planning strategies can be implemented.

Items not impacted by the proposed AMT rules

Amid the changes to the AMT calculation, certain components of the rules are unchanged, including:

• The principal-residence exemption remains available to shelter a capital gain realized on the sale of an eligible principal residence.
• The special foreign tax credit remains fully deductible against AMT taxable income.
• The dividend gross-up amount remains fully deductible in the AMT calculation and no dividend tax credit is allowed.

Next steps

While AMT is a targeted measure and intended to raise revenue from high-income individuals, it is also a measure that may reward sound planning. For that reason, affected taxpayers should consult their tax advisors to assess whether any planning may be available before the proposed AMT rules come into effect and to determine how to minimize exposure in 2024 and subsequent years.

 

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP Canada

• Ameer Abdulla, Waterloo, Ontario
• Sandra Hamilton, Toronto, Ontario
• Amaris He, Toronto, Ontario
• Hayat Kirameddine, Edmonton, Alberta
• Ken Kyriacou, Toronto, Ontario
• Leah Shinh, Toronto, Ontario
• Troy Stanley, St. John’s Newfoundland and Labrador
• Andrew Stevens, Toronto, Ontario
• Perry Yuen, Vancouver, British Columbia

Published by NTD's Tax Technical Knowledge Services group; Carolyn Wright, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.