Leviathan must be stopped

By Trevor R. Parry

Law360 Canada (June 13, 2024, 10:53 AM EDT) -- The Leviathan was a biblical sea monster that devoured all. Christian theologians associated it with the sin of envy, and the English political philosopher Thomas Hobbes used the name for the title of his seminal work. Hobbes argued that a social contract where the individual surrenders personal liberty to an absolute sovereign in return for security is better than chaos. It seems the Trudeau government has decided Canada should be home to this beast.

The announcement that the capital gains inclusion rate should be increased from 50 per cent to two-thirds is the pinnacle of eight federal budgets in which tax increases, and a pernicious bias against entrepreneurs and incorporated professionals, are notable achievements. When Finance Minister Chrystia Freeland said that once again the “very wealthiest” would be paying their “fair share” and that only 40,000 individuals — 0.13 per cent of the population — would be affected by this latest tax hike, the statement showed a tenuous relationship with the facts.

I said as much when I was a guest on Two Way Traffic, a podcast hosted by Darren Coleman of financial services firm Raymond James, on May 30.

The Liberal proposal was delivered without draft legislation and with a date to go into effect — June 25.

What the government didn’t say was that those who fall into this engineered frenzy of panic selling will likely walk into a buzzsaw called Alternative Minimum Tax (AMT). The AMT changes, which took effect Jan. 1, already have an 80 per cent inclusion rate for capital gains. The feds also claim that the measure is part of their dystopian dirge of “fairness,” omitting that a capital gain is generated from assets on which tax has already been paid.

In fact, the proposed change to the taxation of capital gains will affect a wide swath of the Canadian middle class. Capital gains are generated when capital assets, including portfolio investments, real estate and shares of a private corporation are sold or when a taxpayer dies. Currently, half the amount of the gain, which is the amount by which the sale value exceeds the cost base, is included for tax purposes. That gives rise to an effective tax rate of about 27 per cent. Given that our tax system is based upon the concept of integration, the tax result for a corporation or individual should be about the same.

I say should because the new regime will see integration torn asunder as corporations and trusts will see two-thirds of all gains subject to tax while individuals will be subject to the higher inclusion rate on gains in excess of $250,000. The new effective rate of tax will be roughly 34 per cent for individuals and almost 39 per cent for trusts and corporations. Just as the 2017 rule that sees investment income earned inside a corporation reduce its ability to claim the Small Business Deduction on Active Business Income, this new measure further discourages investment and savings.

Other ramifications of an increased capital gains tax are less akin to a pebble being dropped into a pond than lobbing a cinder block into a puddle. For example, a $300,000 capital gain realized inside a corporation (or related corporation) that would have resulted in the loss of the Small Business Deduction will now occur with a gross capital gain of only $227,000.

The effect on corporate estate planning is even more profound. The higher inclusion rate results in a smaller credit to a corporation’s Capital Dividend Account (CDA). Tax planners understand that CDA is the quintessential value required to avoid double taxation and potentially reduce tax upon the death of a shareholder of a private corporation. That of course, includes lawyers who maintain professional corporations or holding corporations.

Traditionally, absent a spousal rollover and adequate CDA to implement a tax-free redemption of shares, tax professionals would implement a loss carryback strategy or pipeline transaction. However, absent further planning, both of those strategies have lost much of their lustre. Also, the amount of taxable dividend required to see a return of any outstanding Refundable Dividend Tax on Hand (RDTOH) balances will be sharply increased.

The simple fact is that far more Canadians and their families are targeted by a government drunk on a confiscatory tax system. The tax and estates bar must point out to its clients that any estate with a gain in excess of $250,000 will now be subject to a higher rate of tax. Anyone who managed to buy a rental property, squirrel away investments or enjoy the family cottage is the true target of this measure. Of course, there are measures and strategies that can mitigate, if not defeat, these changes.

The Canadian electorate is on to Trudeau’s and Freeland’s game. It has nothing to do with equity, fairness or levelling the playing field but punishing achievement, impoverishing the middle class and making them subservient to their own Leviathan.

Trevor R. Parry is a tax strategist and lawyer who was called to the Ontario bar in 1996. He served as a bencher of the Law Society of Ontario from 2019–2023. He actively works with entrepreneurs, professionals and their advisers and counsel in prudently reducing tax wherever possible.

The opinions expressed are those of the author and do not reflect the views of the author’s firm, its clients, Law360 Canada, LexisNexis Canada or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.