Once the darling of Canadian tax breaks, the tax system's preferential treatment of capital gains and losses is no longer as important to the average Canadian investor as it used to be, experts say.
The government has done such a good job encouraging individual savings through registered retirement savings plans and tax-free savings accounts that getting a tax break on stock gains is not as relevant as it once was.
"It's really only the wealthy who have taxable investment accounts and, as a result, capital gains only apply to those sorts of people who have those sorts of accounts," says John De Goey, vice-president and associate portfolio manager at Burgeonvest Bick Securities Ltd. in Toronto.
These days, the vast majority of people who invest do so primarily through RRSPs or TFSAs.
According to information provided by the Canada Revenue Agency, 1.79 million tax filers reported taxable capital gains for the 2010 tax year, which works out to only about 7.3 per cent of all tax filers — compared to the 26 per cent who had RRSPs that year.
"For the very large lion's share of Canadians, [capital gains] is moot," said De Goey.
The basics of capital gains tax
A capital gain, or loss for that matter, is the difference between an asset's total cost price and its total sale price. Simply put, if you purchased $10,000 worth of a given stock and then sold it for $11,000, you would have a capital gain of $1,000.
Investments in tax-sheltered vehicles like an RRSP, TFSA or registered education savings plan are not subject to capital gains tax.
The tax is also not applied when you sell your primary residence, though it can be if you sell a cottage, second home or commercial property.
In Canada, the so-called inclusion rate is 50 per cent, meaning only half the value of a capital gain is included in the income tax calculation.
For instance, if you lived in Ontario and were in the highest tax bracket, you would pay a tax of 42.16 per cent on half of your capital gain, or 21.08 per cent on the whole thing, if you like.
Qualifying small business owners, moreover, can claim a lifetime capital gains exemption of $750,000 if the business is sold after March 18, 2007. Prior to that, the exemption is $500,000.
A capital loss, on the other hand, can be used to offset your taxable gain in any of the three preceding tax years or any future year.
A lower tax regime for capital property — whether that property is stocks, business capital or real estate — is based upon a simple but long-standing notion held by economists: if you cut the cost of investing, you boost the profitability of such investments and, ultimately, get more cash going into productive capital.
The economy gets more investment into important areas, so the argument goes, and individuals make more money that can be reinvested or saved.
History of capital gains
The capital gains tax was introduced in 1972, with an inclusion rate of 50 per cent.
While Canada had a lower effective tax rate on capital gains for some years, people really only began getting excited about this tax in the mid-1980s as more and more Canadians began looking at the stock market as a viable place for their saved money.
Lowering the capital gains
Over the past few decades, a number of industrialized countries have moved to lower the tax burden on capital gains 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.
The government of Conservative Prime Minister Brian Mulroney brought in new rules that gave individuals a lifetime capital gains exemption of $100,000. That meant investors could take a profit on their stocks or real capital of that amount without the taxman getting any of it.
The inclusion rate, however, was raised to 66.67 per cent in 1988 and to 75 per cent in 1990.
The fiscal austerity theme of the Liberal government that came into power in 1993, with Paul Martin as finance minister, led to the elimination of the deduction amount for stocks and passive types of capital.
The inclusion rate was lowered by the Liberal government of Prime Minister Jean Chrétien to 66.67 per cent in February 2000.
In October 2000, that rate was further reduced to 50 per cent. The government also raised the exemption amount for qualifying small business owners to the current $750,000.
The diminished importance of Canada's capital gains tax regime is a function of the fact that a larger portion of Canadians now owns RRSPs or tax-free savings accounts.
And they can put stocks in both vehicles and accumulate the gains on a tax-free basis, although a person does pay tax on an RRSP when the money is withdrawn.
So, while people might own more equities than in the past, they just don't need the incentive of a capital gains tax break, experts say.
Adrian Mastracci, a portfolio manager and financial planner with Vancouver-based KCM Wealth Management Inc., says most Canadians don't have enough money to max out their RRSP or TFSA contributions.
In 2010, for example, just a little more than one-quarter of eligible Canadians contributed to their RRSPs, depositing a total of $33.9 billion, or only 5.1 per cent of the total amount they could have stashed away.
Few people have the money to purchase property or investments that would incur capital gains tax.
"There is a lot of pressure on cash," Mastracci says. "It's not unusual that the TFSAs gets done to some degree, maybe the RRSPs gets done to some degree, but maybe nothing gets done fully."