19 September 2019
According to Arnold and Edgar, the introduction of capital gains tax was both strongly similar in certain aspects and very different in others, compared to the tax implementations in Australia, New Zealand, the U.K. and the U.S. In New Zealand, no general capital gains tax is applied to local investments, while the remaining economies have introduced very similar capital gains taxes.
In the U.K. it was implemented in 1965. Australia joined in 1985. In case of the U.S., the situation is more complex, with capital gains and changes to the highest marginal tax rate proposed in the list of changes including the Tax Reform Act of 1986. The Act included capital gains in income fully, but cut the maximum marginal rate of tax for individuals significantly.
Another common thing is the exclusion of gains on the sale of the principal residence. The U.S. rules are stricter, though. In case of Australia, also up to two hectares of the surrounding land may be included into the exemption, while Canada accepts only 0.5 hectares.
“Such an exemption shows the political sensitivity and social significance of the family home,” – said Arnold and Edgar.
The current campaign controversy proves this topic is still painful.
Three-quarters of Canada’s national wealth is represented by the real estate, with principal residences accounting for the big share of it. A tax on the gains from a principal residence sale would seriously affect homeowners who have been shifting all their investments to their homes for many years.
The tax could also hit the residential real estate markets, affecting domestic consumption.
As 68% of Canadian households are homeowners, all changes affecting their wealth negatively would not help during the election campaign.
It should be noted that Canada is different from other economies in terms of the tax implementation. First of all, in 1985 the lifetime capital gains exemption was introduced. Since 1995, it can only be applied to small businesses, farmers and those in the fisheries.
The second difference is capital gains taxes not accounting for inflation. As the initial capital cost is not indexed for inflation, people who pay the tax on realized gains do it based on an increased value, mostly due to inflation and not to a real value growth of the asset.
Meanwhile, Australia, the U.K., and the U.S. have indexation allowances to deal with the influence of the inflation on capital gains.
Not accounting for inflation in capital gains is one of the reasons for the supply of purpose-built rental construction disappearing almost fully in Canada.
Although many believe the sharp decrease in purpose-built rental construction was caused by the rent control in the 70s, the rental construction still started to drop sharply right after the capital gains tax was introduced.
Even now, the purpose-built rental supply in Canada has not recovered fully to the results we’ve seen before the introduction of the capital gains tax.
We don’t need the extension of the capital gains tax. The parties racing during this election campaign have a great chance to include progressive measures in their platforms which could improve the welfare of Canadians.
The only way to make investors change their mind over participating in purpose-built rental construction is accounting for inflation in capital gains. This will also improve the vacancy rates and ease the increasing pressure on rents.