Although Canada’s recent federal budget was widely described as ‘wait-and-see’ and made no changes to the way capital gains are taxed, Finance Minister Bill Morneau did say amendments to the way profits from selling off personal assets are taxed could be made in the not-too-distant future.
Speculation around a possible increase to capital gains tax rates was rife in the lead up to the budget and investors breathed a collective sigh of relief when no changes were announced. So, what is behind Morneau’s comments? “The government has two objectives when looking to increase the capital gains inclusion rate: one is to fix the difference between how capital gains and dividends are taxed,” says John Wonfor, Global Head of Tax at BDO – international. “Secondly, they simply need more revenue and want to get that via increased tax on capital gains.”
In the budget last week the government announced it will create a discussion paper examining how private companies in Canada engage in tax planning. Under the current rules, there are significant differences in corporate and personal tax structures and Canadians are able to use private corporations to split their income and avoid directing all profits to the main shareholder. “Someone who runs their own business through a corporation can get significant tax deferrals,” Wonfor says. “Private companies can arrange their affairs to realize income as a capital gain rather than a dividend and achieve large tax breaks.”
The common consensus is that an increase in the capital gains tax rate would have a negative impact and certain sectors of the economy are growing incasingly concerned. Capital gains are usually realized when somebody exits from a business investment and in the tech sector particuarly, selling a company is a common exit strategy and income generating tool. It’s fair to say that investors are playing close attention to the government’s next move.
“By increasing the inclusion rate, you put a different incentive on economies to take risk and that is perceived to be negative, particularly for a government who wants to encourage entrepreneurial activity,” Wonfor says. “The government has to be very careful on what they do on capital gains. Personally, I think a broad capital gains tax rate increase is not a good policy decision, and I think a lot of private companies are concerned.”
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