Companies, asset managers in a quandary with capital-gains tax increases

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Large real estate owners, private equity companies and other asset managers have been thrown into disarray after the federal government hiked capital-gains taxes, with companies unsure of their next steps and some rushing to close deals before the new tax regime goes into effect in late June.

The new measures announced in Tuesday’s budget will require businesses and individuals to pay tax on two-thirds of their capital-gains earnings, up from one half, when they sell their assets such as office buildings and stocks. The higher tax will chip away at their profits at a time they are dealing with the spike in borrowing costs.

“This is a pretty big change,” said John Lennard, a Stikeman Elliott partner and tax expert who works with companies and large institutional investors. “It affects essentially every type of company, right? Every type of corporation, individuals, anybody who holds capital property,” he said.

Mr. Lennard said Wednesday that he was already fielding calls from clients concerned that deals that were recently brokered will be subjected to the higher capital-gains rate that is set to take effect June 25. “Now they’re saying: ‘Well, let’s try to perhaps accelerate the closing,’” he said.

The proposed hike to the capital-gains tax set off a flurry of calls between private equity companies and their advisers, and raised concerns about competitiveness and investment returns.

In most cases, asset owners will be hard pressed to sell companies or other assets quickly enough to reap investment gains before the tax takes effect.

It takes time to market an asset. Prospective buyers typically get a minimum of 60 days to conduct the necessary due diligence. For example, in real estate, all types of work need to be completed such as structural engineering reports and environmental assessments.

“To run a process and actually get an asset disposed by June 25, you would have had to start the process months ago,” said Benjie Thomas, Canadian managing partner for KPMG’s advisory practice.

If a company or private equity company decides to put the asset up for sale, potential buyers would have the upper hand because they know the seller is trying to complete the sale by the end of June.

Mr. Thomas said “your value expectation might slightly change” if prospective buyers know a private equity owner is in a rush to sell.

“You’d have to basically sell the asset under fire-sale conditions, which is going to completely erode whatever tax advantage you get out of it,” said Carl Hinzmann, a tax specialist and partner at law firm Gowling WLG, who works with companies and investors.

Private equity and real estate executives said the higher capital-gains tax is counterproductive at a time when Canada is struggling to boost its productivity rate and seeking to attract more capital to invest in the country.

Gordon Chu, a partner in the Toronto M&A tax practice at KPMG, fielded a call on Wednesday from a large U.S. private equity client that has made infrastructure investments in Canada and has live deals in the works.

“Now, they’re re-evaluating, well, maybe we don’t do these projects. Or maybe the margins aren’t as safe as they were before,” Mr. Chu said. “Those are real conversations which are happening in real time.”

Veronica Green, a vice-president with Slate Asset Management, a real estate and investment company, said the new tax was “not good for the Canadian economy, and all real estate owners.”

“If I’m a business and I’m making less money, then that’s not a good thing,” she said. “That’s less money I have to pay my employees, reinvest in my company and also pay rent.”

The federal government’s surprise budget announcement could further slow sales of office buildings, apartment buildings, warehouses and other types of commercial property at a time when activity has been hit hard by higher borrowing costs. It could also further slow the private equity market.

“It’s not going to be a direct drive that they increase the capital-gains tax and now we’re losing all our investment and money’s not coming to Canada. But I would say we are marching down the path of making Canada not as attractive as other jurisdictions,” said Grant McGlaughlin, partner and co-leader of the private equity practice at Fasken Martineau DuMoulin LLP.

Some experts have predicted a rebound in deal-making as central banks signal that rate cuts could start later this year. But owners that can’t meet the June deadline to sell assets may instead wait to see how the changes play out before making business decisions.

The proposed new tax “is just something else that’s put a knot in the wheel,” Mr. Thomas said. “We’re going to lose momentum versus gain momentum.”