One Comment About Taxation – Reflections About The 2024 Canadian Federal Budget

 

By the time you read this, the Canadian federal budget will have been released for a week which has been plenty of time to absorb just how terrible it is.

It starts with its weak fiscal policy, excessive spending and growing public debt charges (estimated to be $54.1 billion for the upcoming year. Yes, that is over $1 billion per week that Canadians are paying for costs that have no societal benefit).

Next, the budget clearly illustrates this government’s continued weak taxation policies. Before I get to the highlight tax proposal – the capital gains inclusion rate increase – there were two other highlight proposals that are apparently good for entrepreneurs.

First, the proposed $2 million “Canadian Entrepreneurs Incentive” (CEI) (which, if eligible, results in a reduced capital gains inclusion rate of 33%) and second, the proposed $10 million capital gains exemption for transfers to an Employee Ownership Trust (EOT) – are both laughable.  Why?  Well, for the CEI, virtually every entrepreneurial industry (except technology) is not eligible. If you happen to be in an industry that qualifies, the $2M exemption comes with a long stringent list of criteria (which will be very difficult for most entrepreneurs to qualify for) and the $2 million is phased in over a 10 year period of $200K per year. For transfers to EOTs, the entrepreneur must give up complete legal and factual control upon such a transfer to be eligible for the $10 million exemption even though the EOT will likely pay the entrepreneur out of future profits.  The commercial risk associated with such a transfer is likely too great for most entrepreneurs to accept.

But the highlight budget proposal was the increase in the capital gains inclusion rate from 50% to 66.67% for dispositions effective after June 24, 2024.  Yes, the proposal includes a retention of the 50% inclusion rate for individuals of the first $250K of annual capital gains but not for corporations and trusts.  Oh, those evil corporations and trusts.

There is lots wrong with this proposed policy.  The first is that by not putting individuals, corporations and trusts on the same taxation footing for capital gains taxation, the foundational principle of integration (the idea that the corporate and individual tax systems should be indifferent to whether an investment is held in a corporation or directly by the taxpayer) is thrown completely out the window.  This is wrong.

Despite the fact that some economists have come out in strong favour of the proposal, mainly because of “equity” arguments (a buck is a buck), such arguments ignore the real world of investing where investors look at overall risk, liquidity and the time value of money.  If capital gains are taxed at a rate that is approaching wage taxation rates, why would entrepreneurs / investors want to risk their capital where such investments might be illiquid for a long period of time and be highly risky?

Such people will seek greener pastures for their investment dollars and they already are.  I’ve been fielding a tremendous amount of questions from investors over the last week and I’d invite academics and those economists who support the increased inclusion rate to come live in my shoes for a day to see how the theoretical world of “equity” and behavior collide.  It’s not good.  And it certainly does nothing to help with Canada’s obvious productivity challenges.

Of course, there has been the usual chatter from people who don’t understand basic economics and taxation policy that are encouraging such people to leave (“don’t let the door hit you on the way out” some say) but I’d caution such cheerleaders to be careful what they wish for.  The loss of successful Canadians and their investment dollars affects all Canadians in a very negative way.

The government messaging around this tax proposal has many people upset, including me.  Specifically, it is the following paragraph in the budget documents that many supporters are parroting:

“Next year, 28.5 million Canadians are not expected to have any capital gains income, and 3 million are expected to earn capital gains below the $250,000 annual threshold. Only 0.13 per cent of Canadians with an average income of $1.4 million are expected to pay more personal income tax on their capital gains in any given year. As a result of this, for 99.87 per cent of Canadians, personal income taxes on capital gains will not increase.” [This is supposedly about 40,000 taxpayers]

Bluntly, this is garbage. It outright ignores the fact that:

– there are hundreds of thousands of private corporations that are owned and controlled by Canadian resident individuals.  Those corporations will be subject to the increased capital gains inclusion rate with no $250K annual phase-in.  Because of the way passive income is taxed in those Canadian-controlled private corporations, the increased tax load on realized capital gains will be felt by those individual shareholders on a dividend distribution required to recover certain refundable corporate taxes;

– public corporations who have capital gains will pay tax at a higher inclusion rate and thus result in higher corporate tax which will be felt by decreased amounts available to be paid out as dividends to individual shareholders (including those held by individuals’ pensions);

– there are millions of Canadians who hold a second real estate property – either a cottage type and / or rental property.  Those properties will eventually be sold with the probability that the gain will exceed the $250K threshold;

– Upon death, an individual will often have their largest capital gains realization as a result of deemed dispositions that occur immediately prior to death.  This will have the distinct possibility of capital gains that exceed $250K; and

– people who become non-residents of Canada – and that is increasing rapidly – have deemed dispositions of their assets (with some exceptions).  Such affected people will face the distinct possibility that such gains will be over $250K.

With respect to affected corporations, the budget documents simply measure the number of corporations that reported capital gains in recent years and states that it is 12.6% of all corporations.  That measurement is shallow and not the whole story as described above.

All told, the government has continued to double-down on its speaking points of 0.13% affected despite mounting pressure.  Again, it’s misleading and untrue. I’ve had people chat with me over the last week that repeat this trope.  I’ve had to spend time explaining why it is simply not true.  It shows the power of misleading messages.

Lastly, the politics around the capital gains inclusion rate increase is pretty obvious. The government is literally “planning” for Canadian taxpayers to “crystallize” their inherent gains prior to the implementation date of June 25, 2024, especially for corporations who will not have a $250K annual lower inclusion rate. For the current year, the government is projecting a $4.9 billion dollar tax take.  But the next year, it dramatically drops to an estimated $1.3 billion.

This is a ridiculous way to shield the government’s tremendous spending and try to make them look like they are “holding the line” on their out-of-control deficits.  The government is literally encouraging people to crystallize their gains and pay tax. That’s a hell of a fiscal plan.  Not.

The old saying holds that tax should not wag the tail of the investment dog but that is exactly what the government is encouraging Canadians to do in the name of raising short-term taxation revenues.  It is simply wrong.

I hope the government has second sober thoughts about the capital gains proposal but I’m not holding my breath.

 

One Comment About Leadership – Good Leaders Make It Happen

 

One of my favorite leadership authors is Noel M. Tichy and his classic / famous book The Leadership Engine.  I’ve mentioned that previously in this newsletter.  His book is simply a gem and I return to it regularly to remind myself of some of the gems.

This past week, I returned to Chapter 7 of his book.  The title of the chapter is “Making it Happen – Getting Energy Out of Everyone”.  It’s a brilliant chapter that discusses:

–        “Winning leaders are high-energy people “who are focused, determined, like challenges and enjoy their work”.

–        “Winning leaders create energy in others” and motivate others with their enthusiasm and actions.  Their stretch goals inspire ambitious efforts.

–        During “times of transition”, leaders use such moments to turn them into “teachable moments” by turning negative energy into positive uses and “if they don’t have a problem, they create one”.

There’s a lot to learn from the above teachings.  One of my friends, who I consider to be a great leader, has a tagline that he uses for his business:

“Creating value others can’t by seeing what others don’t”.

I think that tagline summarizes nicely some of the teachings in Chapter 7 of The Leadership Engine.  There are often opportunities in others’ challenges or in challenging issues that one faces.  A good leader will carefully reflect on such challenges, look for the opportunities and inspire others around them with genuine (not fake) enthusiasm and teachings.

Leaders, what value can you help create in your organization and teammates by seeing opportunities that others don’t?  Go make it happen.

 

One Comment About Economics: Parliamentary Budget Officer Report on the Cost to the Canadian Fisc on the Use of Employee Ownership Trusts

 

As mentioned in the tax comment above, the 2024 federal budget released details on the eligibility of the $10M exemption on transfers to an Employee Ownership Trust (“EOT”) by entrepreneurs.  I stated above that such a proposal is laughable. If you missed that comment and / or the reasons why, have a peek above.

Yesterday, the Parliamentary Budget Officer for Canada (“PBO”) released a Legislative Costing Report entitled “Supporting Employee Ownership Trusts”. The PBO was asked what the $10M exemption will cost the government over the next 3 years.  The answer:  a whopping $23 million.  In the tax world, that is almost not worth mentioning.  (And in the 2024 Federal Budget Documents, the costing amount was indeed zero!).  Sure, that is a lot of money to the average Canadian but is the government really putting its money where its mouth is to try and incentivize entrepreneurs to transfer to an EOT?  No.  Not even close.  If the eligibility rules were not so restrictive and / or enabled the transferring entrepreneur(s) the possibility to retain some equity and voice in the running of the business, then perhaps this would be more enticing.  Until that time, I really don’t see many situations where the entrepreneur would be prepared to accept the commercial risks associated with such a transfer.

In the closing comments of its Report, the PBO stated the following:

The estimate is based on historic values, which may differ in the future. It is linked to the number of private businesses sold, their valuation at the time of sale as well as the number of shareholders/owners selling a CCPC. The number of private corporations sold to an EOT may differ to observed UK experience due to a potentially different willingness by business owners to sell to an EOT, the temporary nature of the Capital Gains Tax exemption in Canada, as well as the order in which Budget 2024 measures are applied. The estimated amounts of capital gains realised considers a behavioral response, but the extent of this response remains uncertain.

I agree with the PBO.  Mark my words, the pick-up on the EOT proposals will be almost negligible in its current form.

 

Bonus Comment – Quote From Dave Weinbaum – Author and Podcaster – About Making Things Happen

 

“Those who let things happen usually lose to those who make things happen”

 

Yep, totally agree!  Leaders, I challenged you above but now I’m specifically asking you:  are you making things happen?

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