There’s been talk since last year’s budget that the Trudeau government might raise the capital gains inclusion rate to three-quarters or two-thirds.cacaroot/Getty Images/iStockphoto
Speculation that Ottawa will hike capital-gains taxes in next week's budget is spreading fear among Canadians sitting on large paper profits in stocks, real estate and other investments.
Rumours have swirled since last year's budget that the Trudeau government might raise the capital gains inclusion rate to three-quarters or two-thirds, taking in billions of dollars a year in extra revenue, mainly from wealthier Canadians.
Ottawa currently taxes half of the profits Canadians earn on the sale of capital property, such as real estate, stocks, bonds or a business.
Even the whiff of a possible change has triggered a blowback on Bay Street and in the business community, where the capital-gains issue is seen a measure of the Liberals' willingness to tax the rich. Critics warn that raising the tax now will undermine Ottawa's efforts to spur innovation and investment, while putting Canadian tax rates dangerously offside competing countries – most notably, the United States, where President Donald Trump and Congressional Republicans are talking about steep tax cuts for individuals and businesses.
"We live in a globally competitive world and we need to have tax rates that encourage innovation and investment," argued Brian Brophy, a tax partner at Deloitte in Toronto. "We need tax rates that are competitive, particularly with countries that we are in deep competition with for people and capital."
Ottawa has been taking a hard look at a wide range of federal tax breaks, which include everything from moving expenses and mechanics tools to corporate stock options and capital gains. During the 2015 election campaign, the Liberals vowed to find at least $3-billion a year in savings by getting rid of breaks that mainly benefit the wealthy or don't achieve key policy objectives. More recently, however, government officials have suggested that a full review might be delayed beyond this year's budget as the government tries to figure out how far the U.S. will go in slashing taxes.
For an Ontarian in the top tax bracket, raising the capital gains inclusion rate to three-quarters would boost the capital-gains tax rate to more than 40 per cent from the current 26.8 per cent. The result is that an investor with a profit of $100,000 would pocket slightly less than $60,000 after paying tax, compared to $73,240 now.
Canadians do not pay capital-gains tax on the sale of their primary residence, the first $800,000 of gains from the sale of a small business, farm or fishing property, and profits inside registered accounts, such as RRSPs and TFSAs.
Recent tax hikes have pushed the combined federal-provincial top marginal tax rate over the psychological threshold of 50 per cent in most of Canada. That is causing people to ponder "aggressive" tax-planning solutions – even if they might not be wise investments, pointed out Jim McConnery, a partner at accounting firm Welch LLP in Ottawa. "I think the government has gone too far," he said.
Finance Minister Bill Morneau has been coy about his plans, leaving most options on the table as he conducts a sweeping review of roughly $100-billion a year in various federal tax breaks. The review, launched last year, is aimed at ensuring they're "fair for Canadians, efficient and fiscally responsible," according to the government.
The Trump factor could well dissuade Ottawa from doing anything major now on taxes, said Jason Safar, a tax partner at PricewaterhouseCoopers LLP. "If you're creating an environment where there is quite a bit of differential between Canadian and U.S. income-tax rates, people start to consider doing things they wouldn't otherwise, such as move to the U.S.," he said.
The prospect of the first change in the federal capital-gains tax rate since 2000 is causing angst among many taxpayers, and prompting some to act before the budget.
"We've been talking to clients about planning scenarios – so they can protect themselves," Mr. McConnery said. "Most clients aren't doing anything. But we're being pro-active in terms of making sure they are aware of the issue and explore what planning ideas are available."
Individuals can choose to sell assets now, and pay at the 50-per-cent rate. Accountants say there are ways to lock in the lower rate without actually disposing of property, including by transferring assets to a spouse or a partnership. But these tax-planning arrangements can be costly to set up and could prove useless if the government doesn't do anything.
Many financial advisers are highlighting the possible tax change in notices to clients. RBC Dominion Securities Inc., for example, warns that selling investments now to avoid a tax hike is "a calculated risk" that may cause people to crystallize gains for no reason if Ottawa does nothing.
It's unclear how much more tax revenue the move to a three-quarters inclusion rate would bring in because taxpayers may alter their behaviour. Some Canadians may choose to earn more dividend income and defer selling assets. Others may move to lower-tax countries, or avoid coming to Canada in the first place. The left-leaning Canadian Centre for Policy Alternatives has pitched the capital gains move as a way to reduce income inequality because wealthy Canadians are more likely to use it. The group says treating capital gains the same as all other income – effectively, a 100-per-cent inclusion rate – would put an extra $10-billion a year into federal coffers.
A move to a three-quarters inclusion rate would not be unprecedented. The rate was set at 75 per cent from 1990 to 2000, 66 2/3 per cent in 1988 and 1989, and 50 per cent before that. Prior to 1972, capital gains were not taxed. Nine out of 35 OECD countries don't tax capital gains, and a 50-per-cent inclusion rate puts Canada in the top third in taxing capital gains.