In Depth

Capital gains: Canada's out-of-favour tax break

Once the darling of Canadian tax breaks, the country's preferential treatment of capital gains has been relegated to minor league status, as more people put stocks in tax-sheltered vehicles.

Capital gains not the draw they once were

Once the darling of Canadian tax breaks, the country's preferential treatment for capital gains and losses has been relegated to minor league status, experts say.

But the reason for the loss of stature is not neglect by the federal government.

Instead, the government has done such a good job encouraging individual savings through registered retirement savings plans and tax-free savings accounts that getting a break on stock gains is not as important as it once was.

"Probably 80 to 90 per cent of Canadians don't have savings outside of a pension or an RRSP," says Cliff Wiegers, president of Wiegers Financial, a Saskatoon-based financial planning firm.

"For those people, the capital gains breaks don't matter."

The basics of capital gains tax

Canada's lower tax regime for capital property — whether that property is stocks, business capital or real estate — was based upon a simple but long-standing notion among economists. If you cut the cost of investing in various investments, you boost the profitability of such investments and ultimately get more cash going into productive capital.

"When (government) chops the capital gains tax, it increases the after-tax rate of return on real assets like plant, equipment and technology and thus the value of the stock rises," analysts Stephen Moore and Philip Kerpan wrote in 2001 for the Institute for Policy Innovation, a Texas-based conservative think-tank.

The economy gets more investment into important areas and individuals make more money that can be reinvested or saved.

So over the past few decades, the federal government — along with governments in most other industrialized countries — chopped the tax burden on capital through some combination of:

  •  A tax-free allowance for a certain percentage or dollar amount of gain.
  •  A lower tax rate for the included profits on capital sales.
  •  The omission of some portion of a person's capital gains from the income tax calculation.

While Canada had a lower effective tax rate on capital gains for some years, people really began getting excited about this tax in the mid-1980s.

Thirty years ago, individual Canadians began looking at the stock market as a viable place for their saved money.

As well, the government of Conservative Prime Minister Brian Mulroney brought in new rules that gave individuals a lifetime capital gains exemption of $100,000. So men and women could take a profit on their stocks or real capital of that amount without the taxman getting any of it.

Within the next decade, however, the fiscal austerity theme of the Liberal government, with Paul Martin as finance minister, led to the elimination of that deduction for stocks and passive types of capital.

By the mid-2000s, the government of Prime Minister Stephen Harper boosted the tax holiday for small business owners, who could now sell their companies and claim a gain of $750,000 without finding Ottawa's hand in their pocket.

"This is the first time it had been increased since 1988," says Annette Robertson, a spokesperson for federal Finance Minister Jim Flaherty.

For individuals, however, Ottawa now includes only 50 per cent of any capital gain in the tax calculation.

So the real tax rate on stock gains gets chopped because the person's taxable income is lower when compared to straight earned income.

Savings priorities

The diminished importance of Canada's capital gains tax regime is a function of the fact that a larger portion of men and women now own RRSPs or tax-free savings accounts.

And they can put stocks in both vehicles and accumulate the gains on a tax-free basis, Wiegers says.

So people might own more equities than in past years. But they just don't need the incentive of a lower capital gains setup as the main incentive, tax experts say.

On his checklist, Wiegers rates the RRSP as the first priority for a person's savings.

"It gives them the biggest bang for their buck."

After the registered plans, people should drop cash into the newer tax-free savings accounts.

An individual would need the lower capital gains tax only after he or she has maximized their contributions to tax-free savings accounts and RRSPs, he says.

But most Canadians don't have that much spare cash, Wiegers notes.