That Other Tax Promise

November 22, 2006

There’s been much discussion about the Tory decision to tax income trusts, which may now be water under the bridge. The promise not to tax trusts was one part of their election platform, but another important one for investors was the promise not to tax capital gains that were re-invested within six months, which has dropped off the radar compared to the furor over trusts.

Most terrestrial life forms saw that the original capital gains proposal (vague as it was) was unworkable. (As an aside it’s interesting to compare this bald-faced political promise to the trust promise which, though widely believed at the time (including by me), now appears similarly ill-conceived.) A few weeks ago, FinMin Jim Flaherty came as close as I’ve seen to admitting the original proposal was flawed. Glad he’s on board with that one, but where does it go from here? JimmyJoBillyJohnBob will give his economically frisky update tomorrow, and although no measures are expected to be announced, he’ll have to at least briefly genuflect in this direction. So it may be a good time to revisit the topic.

One proposal has been the Mintz–Wilson Capital Gains Deferral Account (CGDA), which would tax various incomes earned on investments in the account, but delay tax on cap gains. I’m not entirely sold on this one; some top-of-the-head problems with it:

  • It discriminates between dividends and capital gains, which at a basic level are essentially the same thing (a dividend is a potential capital gain which was paid out instead). This would create a tax disincentive against paying dividends — Unlevel Playing Field City, AZ (aren’t we tired of that phrase by now?). One could get around this by tax-deferring the dividends too.
  • Incomes in the account would be taxed. Fine, it’s only a CGDA after all. But if you withdraw those incomes, it would make taxable a portion of any realized capital gains in the account. In effect you’d be forced to pre-pay some of your deferred taxes when taking out already-taxed money. Maybe you could try to get around that with the complexity of extra bookkeeping.

At any rate I think that idea needs more critical thought, hopefully others can point things out too. Also, alternate proposals are needed. Here’s my offering:

  1. How about “pulling a Goodale” and starting a public consultation on this? That shouldn’t hurt the markets, since there is a strong potential for improvements. It could also earn the Torys a brownie point with disgrunted trust investors for looking “humble and open”.
  2. Capital gains on securities should be tax-free. OK, dream on, but this is the clean and fair solution, since such tax is either double taxation or a waste of effort. Not to say that double taxation is categorically a bugaboo, but here this seems a reasonable view and it may be a viable political selling point (same argument was used re dividend tax changes), and that’s useful in an overtaxed world.
  3. How about Roth (Tax Prepaid) Savings Plans? This idea has been around a long time, and exists in the US. (A cynic would say having these would level the Canada/US playing field just like the trust-tax exemption for REITs did; “All o’ Dubya’s chillun got REITs” :) ) Unlike 2, this wouldn’t eliminate the basic problem of money locked into high cap gain investments. Or, if you delayed the tax on something placed into a RothSP, it would make taking money out messy again. Of course, it’s not clear how the CGDA would work in this regard either: if the governmentt weasled out and didn’t delay the cap gains tax upon entry (defeating much of the original intent) then I think the RothSP could be superior.

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