Wealth Planning

2021 Federal Budget-Towards a diversification of tax revenue sources?


Jonathan M. Charron, LL.M. Tax, TEP

Tax Lawyer – Wealth & Tax Planning

jonathan.charron@bluebridge.ca

The Canadian federal government will table its budget on April 19. With a record deficit in Canada’s public finances due to the pandemic, the government will necessarily have to find new sources of revenue, fuelling rumours and speculation about new sources of taxation for the Canadian tax base.

In an article published last February, we discussed a possible increase in the capital gains inclusion rate¹, a potential measure widely discussed by the tax community over the past several budgets. But is it possible that the federal government could opt instead for a new form of taxation, in the form of a wealth tax like the one applied in some European jurisdictions, or an estate tax (like the one levied in the United States depending on the estate value)?

With respect to estate taxes, Canada already has what some people call a “death tax.” Under this system, a Canadian taxpayer is deemed to have disposed of all of his assets immediately before death for proceeds of disposition equal to their fair market value at the time. Accordingly, any unrealized gain accruing on capital property held by a Canadian resident taxpayer is taxed at death. The estate therefore receives the assets at a high tax cost (equal to their fair market value), since the unrealized tax expense is crystallized and paid by the deceased at the time of death. It would amount to a form of economic double taxation if the estate were required to pay an additional tax on the value of the estate for the same assets. This measure is therefore not feasible in Canada without a major overhaul of the tax system to avoid such an outcome.

A wealth tax would constitute a new form of taxation in Canada. The federal government stated in its September 23, 2020, Speech from the Throne that it “will also identify additional ways to tax extreme wealth inequality.” In this regard, the Office of the Parliamentary Budget Officer (PBO) tabled a report in July 2020 to estimate the potential revenue of a net wealth tax on economic families residing in Canada equal to 1% of net wealth above $20 million. For the purposes of analysis, all types of assets were included in the net wealth tax base, with the exception of lottery winnings. The PBO estimated that 13,800 Canadian families would pay the net wealth tax and that the total net revenue of this measure would reach $5.6 billion in 2020-2021. The PBO also reduced the net worth of each family affected by this potential measure by 35% based on the anticipated behavioural response rate resulting from tax planning, tax avoidance or simply the potential flight of capital.

Experience in other jurisdictions that implemented a wealth tax shows that this form of taxation is not always as effective as governments might hope. On the contrary, in many cases the projected revenues were not realized and the tax measure was complex and costly to administer. Many jurisdictions abolished the wealth tax for that very reason. While there is no question that it could generate new revenues, certain anomalies inherent in such a potential tax measure demand consideration, including:

  • Some taxpayers hold capital assets of significant value that do not necessarily generate a significant return in the form of net income realized annually. Examples include farmers or taxpayers with real estate or investment portfolios that primarily generate a long-term appreciation in value, rather than an annual net income. In these situations, these taxpayers could frequently face a lack of liquidity, forced to pay the wealth tax but unable to dispose of their capital assets easily.

 

  • Canada presents geographic disparity in the value of certain assets, particularly real estate assets. A building in Toronto or Vancouver is worth considerably more than in other parts of Canada and the cost of living is also different. A wealth tax may place taxpayers who live in areas where the value of certain assets and the cost of living is higher at a disadvantage.

 

  • Real estate assets (especially principal residences) and pension plans are the asset classes that make up the largest portion of Canadians’ wealth. The capital gains realized on a Canadian taxpayer’s principal residence is currently exempt from tax. Would there be any exceptions to the wealth tax for these assets, which for many Canadians constitute their future retirement income? In this case, if we do not tax certain assets such as pension plans, why should we tax the value of shares in a private company (operating or holding company) which, in many cases, ultimately constitutes the economic value that an entrepreneur will use to finance their retirement?

 

  • A wealth tax raises a real risk of capital flight. The PBO notes this in its analysis by applying a theoretical 35% reduction in the wealth of families potentially targeted by a wealth tax, something it calls a “behavioural response rate.” Certainly, an exodus of capital from Canada should be expected, with an impact on the Canadian economy that is difficult to quantify.

 

Jean-Baptiste Colbert, Minister of Finance during the reign of Louis XIV in France, once said that “the art of taxation consists in so plucking the goose as to obtain the largest possible number of feathers with the smallest possible amount of hissing”. Any new tax measure necessarily has both positive and negative effects. The important thing is to ensure a positive balance while more generally considering the potential administrative burden and inherent costs to government and taxpayers.

In short, given the reality of the Canadian tax system, an estate tax should not be an option given that we already do have a death tax. A wealth tax raises certain enforcement difficulties, and the experience of other jurisdictions in this area raises many doubts about the effectiveness of such a tax measure. It remains to be seen what fiscal ingenuity the federal government will devise in its next budget.

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By Jonathan Charron,

13/04/2021

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