The government of Canadian prime minister Justin Trudeau is planning to increase the share of capital gains tax paid to 66% for individuals with annual investment profits in excess of CAD 250,000 (GBP 145,000). Companies and trusts are also going to fall into the new tax regime, according to budget details published last month.
Canada’s finance minister, Chrystia Freeland, has proposed hiking CGT on both companies and individuals from the current 50% to two thirds. She is arguing the tax will only really affect 0.13% of Canadian private citizens and around 12% of businesses, although some local business groups beg to differ.
The change is expected to bring in another CAD 19.4bn (GBP 11.3bn) into the public coffers over a five year period. The changes were not included in the main Canadian budget and will be brought into being using separate legislation.
Why are the Canadian CGT changes bad for Canadian resources companies?
The Canadian government is planning to bring in this new measure from 25 June. The plans could endanger the ability of many smaller resources companies currently listed in Canada – e.g. on the TSX Venture Exchange – to raise funds through flow-through shares. The current regime lets wealthy investors take advantage of tax deductions being renounced by issuers.
The Canadian flow-through share regime lets public companies transfer to investors certain expenditures conducted on Canadian soil. In addition to regular flow-through shares, which provide 100% deduction for exploration, the federal Canadian METC (Mineral Exploration Tax Credit) provides a 15% non-refundable tax credit that can be used by grass roots explorers in Canada. This can be deducted from federal income taxes.
In the 2022 budget, the government increased the METC rate to 30% for certain critical minerals, over a five year period until 2027. Canadian provinces also provide other tax breaks on provincial income tax – e.g. Quebec lets investors deduct up to 120% of the cost of some qualifying exploration expenses that are incurred by non-producing companies.
Minimum flow-through investments are substantial – at CAD 250,000. These are important for Canadian small caps, accounting for a staggering 65% of all the funds that are raised on Canadian markets by mining companies. Junior miners raised close to a billion Canadian dollars using flow-through shares in Canada in 2023.
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Mining companies are arguing that flow-through shares are a critical part of the financing needed to keep risky venture operations like theirs moving forwards. The mining industry is currently lobbying the government in the hopes that flow-through shares will be exempt from the new Canadian CGT plans. Some miners fear the tax could cripple the junior mining sector in Canada overnight if it is applied.
Market participants in Canada are worried that the new tax plans will further discourage investment in Canadian smaller companies.
A wide range of Canadian business groups are openly critical of the proposed tax, including the Canadian Chamber of Commerce and the Canadian Venture Capital and Private Equity Association.
Employee stock options
The tax also seems to anticipate that some wealthy Canadians may leave the country in search of more tax-friendly jurisdictions. The change applies to any dispositions of assets, including deemed dispositions on a departure from Canada or death. Also in scope are stock options deductions.
According to KMPG, where an individual claims the employee stock option deduction, the budget provides a one third deduction of the taxable benefit to reflect the new capital gains inclusion rate, but that individual would be entitled to a deduction of half the taxable benefit up to a combined limit of CAD 250,000 for both employee stock options and capital gains.
“The budget notes that net capital losses of prior years would continue to be deductible against taxable capital gains in the current year by adjusting their value to reflect the inclusion rate of the capital gains being offset,” said Sonia Gandhi, a partner with KPMG in Canada. “As a result, a capital loss realised prior to the rate change would fully offset an equivalent capital gain realized after the rate change.”
