Moody: Capital gains hike up in the air, but you have to prepare

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Most people know that capital gains are preferentially taxed in Canada, like most countries, and for good reason: prosperous countries realize that investors, including entrepreneurs, take significant risks that can have extended long-term benefits to society and the economy.

That explains the concerns over Canada’s introduction of complex proposals earlier this year to increase the capital gains inclusion rate effective June 25, 2024. But for those who continue to mindlessly bleat out the “buck is a buck is a buck” line in support of the proposals, I’ll repeat something former finance minister Edgar Benson said in 1969:

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“The government rejects the proposition that every increase in economic power, no matter what its source, should be treated the same for tax purposes. This proposition, put forward forcefully by the Royal Commission on Taxation, has often been summarized rather inelegantly as ‘a buck is a buck is a buck,’” he said.

“But although the government does not accept this theory in all its splendid simplicity, neither does it believe that the distinction between a so-called ‘capital gain’ and an income receipt is either great enough or clear enough to warrant the tremendous difference from being completely exempt and being completely taxable.”

I also often hear that “employment risk is absolutely the same as entrepreneurial and investor risk.” Hogwash. I challenge those people to put their money where their mouth is and put up their life savings — including their gold-plated pensions — to start a business. You think it’s easy? You think it’s a guarantee to riches? Do it. I dare you.

But the question remains whether the capital gains inclusion rate increase will become law given that there is not currently a bill before Parliament and some opposition parties have made it clear they would like to topple the government. Accordingly, there is political risk that could delay or even permanently suspend the proposals, thus keeping the current 50 per cent inclusion rate as the benchmark.

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Is that possible? The short answer is, yes, it’s possible.

I often provide a caveat to this answer, though. For those of you who like mindless comedy like I do, I often use a famous line from the 1994 movie Dumb and Dumber as the caveat. The goofy main character, Lloyd, asks Mary, a beautiful woman he is infatuated with, what the chances are that they could end up together. She replies that the chance of that happening is about one in a million. “So, you’re saying there’s a chance,” Lloyd excitedly replies.

That kind of summarizes my thoughts about the capital gains proposals not getting passed into law: There’s a chance, but it’s small. With the NDP continuing to prop up the Liberals, it’s likely to proceed, but you never know.

If an election is called before the capital gains proposals are passed, it will die as all bills before Parliament will die. To become law, a new bill would then need to be put before Parliament by the new government. Would the new government be compelled to reintroduce the bills that died as a result of the election call? No. And if it is a new governing party, it would be highly unlikely that the proposals would move forward.

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Would that mean a lot of Canadians have proactively planned as if the proposals would become law (which is usually the right thing to do)? Yes.

What should affected taxpayers do in the meantime? Well, they and the Canada Revenue Agency (CRA) are in quite a pickle. The CRA is charged with administering the law, but the capital gains proposals are not yet law. Should they become law, they will be retroactively in force as of June 25, 2024.

Presently, the CRA has no legal ability to assess affected tax returns on the basis that the capital gains proposals are law. The related tax forms and CRA-approved tax preparation software have not been updated or approved.

Should taxpayers proactively file affected returns in such a way to account for such an impact?

The CRA recently provided some guidance via CPA Canada (which has been proactively dealing with the CRA on this question) that encourages taxpayers to file affected returns on the basis of the proposed legislation using a variety of different options.

I have reviewed the CRA’s suggestions and they make logical sense. In today’s high-interest rate environment, you would generally want to ensure that probable tax liabilities are timely paid so as to avoid possible costly interest charges. Currently, that rate is nine per cent.

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But what if the opposite happens? In other words, if you follow the CRA recommendations and proactively file and pay tax on the basis of the proposed legislation, but the proposals never get passed? In that case, you would need to file an amended return to adjust for the correct amount of taxable capital gains and request a refund for the overpaid tax.

The CRA would also pay interest on such overpayments, but, of course, at a rate lower than the current nine per cent for liabilities. That refund rate is currently seven per cent for non-corporate taxpayers and five per cent for corporations.

What to think of all this confusion? Well, as Albert Einstein famously said, “In the middle of difficulty lies a path to order.” I think that is apropos in the present case.

In today’s uncertain tax environment involving capital gains, it is certainly confusing, but there is a path to order. Canadians would be wise to keep paying attention to this evolving story.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody. 

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