What's missing from the Budget: Where is the plan for capital gains?

National Post

2006-05-06


Tax credits for seniors, students, employees and public-transit users. More
money for childcare and GST cuts for all: It appears Finance Minister Jim
Flaherty's federal budget was chock full of tax breaks and other goodies. What
more could we want?

Perhaps the biggest omission from the budget was the Conservatives'
pre-election promise to "eliminate the capital gains tax for individuals on the
sale of assets when the proceeds are reinvested within six months."

While no one expected this to be introduced as early as this week's budget,
many hoped for indication the government was moving forward on the initiative.

The theory behind the proposal to eliminate -- or defer -- the capital gains
tax when proceeds are reinvested is sound. Under present tax rules, there's a
disincentive to sell an asset that has appreciated significantly in value, even
if it may make sense to do so from an investment perspective. "I just don't want
to pay the tax," is the common refrain from investors when encouraged to
diversify out of a highly concentrated stock position or over-valued asset.

Behavioural finance experts have coined a term for the ailment: "capital
gains lock-in effect."

The stumbling block the Conservatives face is the practical implementation of
the proposal: How do you balance potential tax revenue losses? What about the
nightmarish record-keeping requirements for investors?

The first formal work to be published on how the capital gains deferral
system might be implemented was released by the C.D. Howe Institute a week ago.
The report, titled Removing the Shackles: Deferring Capital Gains Taxes on Asset
Rollovers, was co-written by the Institute's outgoing CEO Jack Mintz, and Tom
Wilson, senior advisor for the Institute of Policy Analysis at the University of
Toronto.

It recommends the introduction of a Capital Gains Deferral Account (CGDA).
This would permit individuals to roll over securities within the account without
incurring capital gains taxes until the securities are actually withdrawn from
the account. Upon such a withdrawal, capital gains taxes would be due,
calculated on a pro-rata basis.

For example, if Sally withdrew $10,000 from her CGDA when the total fair
market value of her CGDA was $100,000, it would be considered a withdrawal of
10% of her original cost base. The difference between the total fair market
value of assets in the plan and the original cost base would be the accumulated
capital gain. Sally would therefore report 10% of any accumulated capital gain
in the account.

For this to work, the original cost base of the contributions of capital
(including any reinvestment of dividends and interest) would need to be tracked.
Income earned within the CGDA (such as interest or dividends) would still be
taxable in the year it is earned. If this income is then left inside the CGDA,
it would be added to the original cost base of the assets.

The report does suggest limits (either annual or lifetime) on the amount
investors may contribute to the CGDA. Imposing limits would control the amount
of revenue loss to the government.

The C.D. Howe report estimates that a CGDA lifetime contribution limit of
$150,000 in contributions would result in annualized revenue loss of about
$420-million.

Let's hope that the CGDA concept sparks renewed discussion and debate in
Ottawa so that the government can move forward on this important initiative.

GRAPHIC: Black & White
Photo: Kier Gilmour, Canwest News Service; Finance Minister Jim Flaherty.