Canada Taxpayers Must Prepare Both Ways on Capital Gains Increase

Canada’s announcement of a capital gains tax inclusion rate increase was last year’s biggest tax development in the country. But political developments are making it unlikely that the tax change will take effect, creating uncertainty for Canadian taxpayers.

The increase was to take effect June 25, but complete draft legislation didn’t follow until August. This isn’t uncommon in Canada, where tax changes often aren’t formally enacted by the announced effective date. In such cases, the legislation to implement the changes typically would be retroactive to the announced effective date for the changes.

The Canada Revenue Agency generally operates on the basis of announced tax proposals and expects taxpayers to comply with those proposals from their scheduled effective date. Consistent with that normal practice, the CRA has been updating its forms and systems to reflect the tax increase.

While the CRA recognizes that it can’t legally compel taxpayers to follow rules that aren’t yet law, it encourages taxpayers to do so once legislation is enacted. This means that a taxpayer who fails to follow proposed tax rules prior to enactment and only pays required additional tax after parliament actually passes the new law, could be subject to interest and penalties for late payment.

This approach to tax administration is considered reasonable because anything the government announces is, in practice, likely to be enacted. Canadian governments generally are supported by a majority in parliament and can ensure that tax measures they propose become law. Many tax changes also are non-controversial and technical—and conventionally would be passed even if a new government took power in the interim.

In this case, it also seemed safe initially to assume that the capital gains changes would be enacted. Although Canada has a minority government, a clear majority in parliament favored this particular change.

However, unrelated political events contrived to prevent the legislation from moving through parliament last fall. With the government likely to fall once parliament reconvenes in March, the likely successor government having committed not to pursue the tax increase, and even the former finance minister who initially proposed the tax increase seemingly now opposed, it appears highly likely that the capital gains tax increase is dead.

Despite this, the CRA continues to follow its normal policy of directing taxpayers to comply with the proposed tax changes. This has left taxpayers with a difficult choice about whether to pay the higher tax that likely won’t end up applying.

If they do, then they probably face a lengthy wait for a refund. If they don’t, then they will be exposed to interest and penalties if, against expectation, the increase goes into effect—and they will also face administrative difficulties not paying because the CRA’s tax forms and systems will be based on the higher rate.

Many taxpayers will have been protected from this particular dilemma by accelerating any capital gains to before June 25, 2024, when there is no question about the relevant tax rate. But this highlights a second issue: that many taxpayers may have chosen not to realize any gains at all had the tax increase not been threatened. Affected taxpayers may want to take a “wait-and-see” approach for as long as possible, in the hope of additional clarity before their tax payment and filing deadlines.

Some sophisticated and well advised taxpayers structured their gain transactions in ways that would allow them to defer any gains by subsequently filing tax elections, specifically to account for the risk of the tax increase not being enacted. Such taxpayers also may want to take a wait-and-see approach, until it is clear whether such election would be beneficial.

However, many taxpayers may not have made such arrangements and won’t be able to “untrigger” pre-June 25 gains. Those taxpayers will have reasons to feel unhappy regardless of whether the capital gains tax increase ultimately goes into effect.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Ian Caines is partner at Davies Ward Phillips & Vineberg, focused on domestic and international income tax law.

Sabina Han is partner at Davies, focused on Canadian commodity tax matters.

Michael Kandev is partner at Davies, focused on transactional taxes.

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