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Economy

Five major issues to consider for the upcoming capital gains tax change

Housing, productivity and innovation at stake with the capital gains inclusion rate increase set to take effect June 25.

The 2024 budget included extensive government spending, partially funded through an increased inclusion rate on the capital gains tax for corporations and individuals. The initiative continues to make   headlines as debate rages over the merits of the move, its messaging and the timing.  

CPA Canada was among the first to draw attention to the fact that the new initiative could capture middle-class Canadians when they have a lifetime tax event, such as the sale of a secondary residence, an investment property or a business. 

But the impacts could be far-reaching for the real estate, tech and corporate sectors across Canada— and for the economy as a whole at a time where we need capital more than ever.   

Solving for short-term revenue needs  

The increased capital gains inclusion rate takes effect on June 25, slightly more than two months after the release of the budget and not long after the deadlines for filling 2023 taxes.  

Budget projections suggest the federal government is expecting, even counting on, asset sales before the deadline — some 35 per cent of the five-year $20 billion revenue projection over five years is expected to be collected this year alone. 

Individuals or corporations who want to avoid the higher inclusion rate need to decide soon to sell assets in that very short time. For financial assets and in-demand real estate, this might be plausible, but for businesses, turning around a sale in such a short period is much more challenging.  

Changing the rules midway through  

The increased inclusion rate is not the highest it has ever been — it was higher in the late '80s and '90s. However, it remained unchanged for more than 20 years and thus, Canadians and businesses made decisions based on the current inclusion rate of 50 per cent of an asset. Not only does changing the rules impact decisions that were made long before the budget, but it also introduces uncertainty for upcoming financial decisions. Should Canadians and businesses expect more increases in coming years in the name of “fairness”?  

Mixed signals for real estate investors could impact affordability 

The government is sending mixed signals to investors. On one hand, they are introducing an accelerated capital-cost allowance (ACCA) in the housing plan which should allow for faster depreciation and thus higher cashflow for new rental builds. On the other, they are hitting all investment properties owners with the increased inclusion rate of capital gains thereby negatively impacting real estate returns. The impact on rents might be neutral for new builds that benefit from ACCA, but it could potentially drive up rents for current housing supply. That’s not a trivial consideration when inflation is now driven by shelter costs and rent.

 

Competitiveness sliding for the tech industry 

By design, the tech industry generates significant capital gains. Not only is it important for founders, but it is also crucial for investors and a significant component of employee compensation. Therefore, the narrowly scoped Canadian Entrepreneurs’ Incentive (CEI), which increase the lifetime capital gains exemption for founding investors, will not be sufficient to counterbalance the ecosystem impacts of an increased capital gains inclusion rate. Based on the government’s budgeted forecast, only three per cent of the increased government revenues will be put back in the hands of entrepreneurs over five years with the CEI. 

Let’s not forget we are competing against our tech powerhouse neighbour to the south and attracting the mobile tech workforce and investors is particularly important. The increased inclusion of capital gains is worsening our tax competitiveness for the sake of meeting short term financial needs. It is misguided and will certainly not help with the lagging weight of intangible assets without our economy to which the tech sector can greatly contribute.  

What message are we sending to corporate Canada?  

The increased inclusion rate on capital is certainly not well timed. It does not help attract capital and investors from abroad or within the country. Yet, they are needed to address our well documented lacklustre performance on productivity and innovation especially when recent quarterly data suggests a widening productivity gap with the United States. Canada is not exactly swimming in entrepreneurship, it currently stands at an all-time low. The number of businesses in Canada has stalled since early 2023 and business insolvencies are higher than before the pandemic. Higher capital taxes will disincentivize risk-taking and could compound the challenges of business succession. The additional revenues from the increased capital gain inclusion will fund spending to redistribute wealth, but could very well hinder future creation of wealth. Economic growth is not a zero-sum game, but a win-win between businesses and Canadians. A strong private sector and profitable businesses undeniably lead to higher-paid workers and better living standards.