# Reason for full inclusion of capital gain into taxable capital gain?



## TaxStudent (Apr 3, 2013)

Dear forum members,

I've recently been given an assignment to provide some reasons as to why all capital gains should be taxable. I know for a fact that in regards to capital gains, only 50% of that becomes taxable capital gains.

One reason that I can think of as to why all 100% of the capital gains an individual acquires should be taxable is because that the gain received may be due to purely market demand.



Anyone able to help me out on this? I've also tried to search on google "100% taxable capital gains", and I managed to find nothing. I've also managed to find "Carter Commission" by just searching randomly with capital gains in the search box, but I couldn't find the ebook anywhere.


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## Robillard (Apr 11, 2009)

Now, I'm not saying that this is a good argument, but one might be that keeping capital gains only 50% taxable results in rich people who receive stock-based compensation being taxed too little. Mid and high-level corporate employees sometimes receive stock options or restricted share units as part of their total compensation. Depending on the circumstances, the taxation of this compensation is treated as capital gains, rather than orginary employment income. Since the marginal capital gains tax rate is half the rate of ordinary income, wealthy people who receive such compensation may pay lower average tax rates than other taxpayers who don't receive it.

On the flip side, in Canada, it's my understanding that stock-based compensation is generally not deductible at the corporate level for tax purposes. So, in order to prevent double taxation, if there were a 100% income inclusion on capital gains at the individual taxpayer level, then stock-based compensation ought to be deductible as an expense for tax purposes by corporations.


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## TaxStudent (Apr 3, 2013)

Robillard said:


> Now, I'm not saying that this is a good argument, but one might be that keeping capital gains only 50% taxable results in rich people who receive stock-based compensation being taxed too little. Mid and high-level corporate employees sometimes receive stock options or restricted share units as part of their total compensation. Depending on the circumstances, the taxation of this compensation is treated as capital gains, rather than orginary employment income. Since the marginal capital gains tax rate is half the rate of ordinary income, wealthy people who receive such compensation may pay lower average tax rates than other taxpayers who don't receive it.
> 
> On the flip side, in Canada, it's my understanding that stock-based compensation is generally not deductible at the corporate level for tax purposes. So, in order to prevent double taxation, if there were a 100% income inclusion on capital gains at the individual taxpayer level, then stock-based compensation ought to be deductible as an expense for tax purposes by corporations.


Thanks alot Robillard, your first paragraph provide me with a really good point as an argument FOR full inclusion. But in regards to your second paragraph where you speak of double taxation, can you elaborate how it may SUPPORT your first paragraph?

From my understanding after reading your explanation, this is my interpretation.

If the stock-based capital gains are only taxed at the individual taxpayer level, and NOT through the corporation, the corporation will be able to classify the compensation as an expense, and will be able to deduct that amount. This effectively nullifies the point of income distribution?

Also is it possible for you to provide me with some sort of source that links to your reasoning? For some messed up reason, any argument that I provide will require a source which specifically states the reasoning.


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## TaxStudent (Apr 3, 2013)

Robillard said:


> Now, I'm not saying that this is a good argument, but one might be that keeping capital gains only 50% taxable results in rich people who receive stock-based compensation being taxed too little. Mid and high-level corporate employees sometimes receive stock options or restricted share units as part of their total compensation. Depending on the circumstances, the taxation of this compensation is treated as capital gains, rather than orginary employment income. Since the marginal capital gains tax rate is half the rate of ordinary income, wealthy people who receive such compensation may pay lower average tax rates than other taxpayers who don't receive it.
> 
> On the flip side, in Canada, it's my understanding that stock-based compensation is generally not deductible at the corporate level for tax purposes. So, in order to prevent double taxation, if there were a 100% income inclusion on capital gains at the individual taxpayer level, then stock-based compensation ought to be deductible as an expense for tax purposes by corporations.



Wouldn't it be bad for the tax system if the corporations will be able to deduct the compensation as an expense?


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## andrewf (Mar 1, 2010)

If we eliminated corporate income taxes, a strong case could be made for eliminating special taxation for capital gains and eligible dividends.


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## none (Jan 15, 2013)

andrewf said:


> If we eliminated corporate income taxes, a strong case could be made for eliminating special taxation for capital gains and eligible dividends.


No thanks.


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## andrewf (Mar 1, 2010)

Why not?


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## MoneyGal (Apr 24, 2009)

The Carter Commission on Taxation was a federal Royal Commission, reporting in 1966: 

http://www.thecanadianencyclopedia.com/articles/royal-commission-on-taxation

Here's the full commission report in electronic format: http://epe.lac-bac.gc.ca/100/200/301/pco-bcp/commissions-ef/carter1966-eng/carter1966-eng.htm


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## Robillard (Apr 11, 2009)

@TaxStudent
I haven't read this article in a while, but I think it addresses the point about the taxation of stock-based compensation: 
http://www.theglobeandmail.com/report-on-business/economy/economy-lab/a-simple-way-to-tax-the-rich/article552647/

In principle, the government should only get to tax income once, not multiple times at multiple levels. So for example, employee wages and salaries are deductible as an expense by businesses (and thereby not taxed at the corporate or business level), but are inluded in the taxable income of employees (and thereby taxed at the individual level). 

It's my understanding that, as it stands, stock option compensation is not deductible for tax purposes at the corporate level (and thereby taxable at the corporate level). But the economic value of the options, the grant date fair value, is not taxable by the recipient of the options until the options are exercised. When the options are exercised, the recipient has a 50% income inclusion on the capital gain income generated.

If employees receiving stock options were taxed on the grant date fair value of options, or maybe if they had to take a 100% income inclusion on the capital gains generated on exercise, there would be a good case for letting corporations deduct the grant date value of the options when they are issued. This would be in line with the principle that the government only gets to tax income once. This is an issue of fairness. 

Basically, it would be bad if options both non-deductible at the corporate level, and fully taxable at the individual level, because it would mean that the government got to tax the same income twice. 

There is a tangential issue, and that is that stock-based compensation might be better thought of not as an expenditure by the corporation, but as dilution of the holdings of existing shareholders. When corporations issue stock to payout on stock options or as part of employee share purchase plans, they don't pay out any real cash. Instead, they dilute (or perhaps "tax") the existing shareholders to pay the employees.


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## Eclectic12 (Oct 20, 2010)

TaxStudent said:


> ... I've recently been given an assignment to provide some reasons as to why all capital gains should be taxable. I know for a fact that in regards to capital gains, only 50% of that becomes taxable capital gains.
> 
> One reason that I can think of as to why all 100% of the capital gains an individual acquires should be taxable is because that the gain received may be due to purely market demand....


I'd argue it shouldn't be taxed at 100% as it is far riskier than say income or a GIC which is taxed at 100%.


In any case - bear in mind that prior to I believe 1972, all Canadian CG was tax free.

I vote we go back to that! :biggrin:


Cheers


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## andrewf (Mar 1, 2010)

You're already getting a risk premium when you buy riskier assets. Why should there be a tax subsidy as well?


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> You're already getting a risk premium when you buy riskier assets. Why should there be a tax subsidy as well?


So if the tax profile is changed - how much of that risk premium will go away as fewer choose to take on the risk?

For that matter - why not take away the tax subsidy of the principal residence and start charging CG on all living spaces instead of just rentals, cottages and business buildings?

Cheers


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## andrewf (Mar 1, 2010)

If fewer people were attracted to risky assets because the tax treatment was made less favourable, then the risk premium (before tax) would increase.

I'm also saying we should consider reducing corporate income tax to zero.

I can see the merits of CG exemptions on primary residences from a book-keeping perspective. If you taxed the CG of homes, you should allow people to capitalize any improvements/repairs to the home. It would significantly increase the recordkeeping burden. Better to level the playing field for renters. Vacation properties--I see no merit in extending tax subsidies to these.


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## Eclectic12 (Oct 20, 2010)

andrewf said:


> If fewer people were attracted to risky assets because the tax treatment was made less favourable, then the risk premium (before tax) would increase.


Maybe ... a company that's trying to run a business such as TRP or BCE probably won't. On the other hand, the MF or private REIT hucksters probably will.




andrewf said:


> I'm also saying we should consider reducing corporate income tax to zero.


In that situation, does the private business owner report the business income as being their personal income?

For public companies that aren't paying dividends - does the income stay tax free as long as it is held by the company?




andrewf said:


> I can see the merits of CG exemptions on primary residences from a book-keeping perspective. If you taxed the CG of homes, you should allow people to capitalize any improvements/repairs to the home. It would significantly increase the recordkeeping burden. Better to level the playing field for renters.


I'm not convinced. 

If I'm a renter and have to pay 100% on my capital gains through investments, am I really going to see someone who makes $80K tax free as a level playing field? Then too, the primary residence home owner has no bookkeeping while the renting investor has a fair amount of bookkeeping to do.




andrewf said:


> Vacation properties--I see no merit in extending tax subsidies to these.


My point was if the idea is to have 100% capital gains taxed - why have an exception for a primary residence?

So far, bookkeeping seems to be the reason - though there are lots of other place bookkeeping is required.


Cheers


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## andrewf (Mar 1, 2010)

Eclectic12 said:


> Maybe ... a company that's trying to run a business such as TRP or BCE probably won't. On the other hand, the MF or private REIT hucksters probably will.


Well, I look at it at the broad index level. The equity risk premium would have to expand for most taxpayers to want to continue to invest. So P/Es would fall. This may not be because of adjustments in 'P' (price), but rather 'E', because corporate earnings would rise by about a third (taxes no longer paid).




> In that situation, does the private business owner report the business income as being their personal income?
> 
> For public companies that aren't paying dividends - does the income stay tax free as long as it is held by the company?


They would pay tax on dividends as ordinary income. Retained earnings would face the same kind of withholding scheme as we have now to ensure integration. So ~48% of income is withheld, then refunded when dividends are paid out. This should probably be extended to share buybacks, which are done with after-tax income currently. Thus high income earners can't defer tax by using a corp vs holding assets personally. But note that the tax burden doesn't change when you look at pre-tax corporate profits to after-tax personal income.


> > I'm not convinced.
> >
> > If I'm a renter and have to pay 100% on my capital gains through investments, am I really going to see someone who makes $80K tax free as a level playing field? Then too, the primary residence home owner has no bookkeeping while the renting investor has a fair amount of bookkeeping to do.
> 
> ...


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## OhGreatGuru (May 24, 2009)

TaxStudent said:


> ...
> 
> I've recently been given an assignment to provide some reasons as to why all capital gains should be taxable. ....
> .


OP is looking for reasons why capital gains should be taxed at 100% inclusion rate; not reasons why they should not be.

Most obvious reason is that the present rule disproportionately favours the idle (as well as not-so-idle) rich. 
If you can find out how much capital gains tax the government collects every year, you could also estimate what the lost revenue cost is to government, which has to be made up for by more taxes on everyone.

PS: favorable tax treatment of capital gains encourages people to invest in equities outside of their RRSPs. This at a time when economists tell us Canadians are not saving enough for retirement, and hundreds of billions of $ of RRSP room are going unused.


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## andrewf (Mar 1, 2010)

Well, it's not so simple as just doubling revenue from capital gains tax. People respond to incentives.


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## OhGreatGuru (May 24, 2009)

andrewf said:


> Well, it's not so simple as just doubling revenue from capital gains tax. People respond to incentives.


I don't dispute that it is not so simple. People might change their asset allocations; a lot of stockbrokers might lose their jobs (good or bad?); amount of investment capital available might drop, etc. But possible undesirable consequences are reasons not to change the inclusion rate, whereas OP asked for reasons to change it.


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## andrewf (Mar 1, 2010)

I can't think of any good reasons to make that change in isolation. If I were pressed, I think the best arguments are:

-A higher inclusion rate on capital gains would tend to fall more on wealthier taxpayers, and would increase progressivity of the tax system
-It would likely lead to an increase in tax revenues, somewhere between the current level of capital gains revenue and twice that level. This would actually require some sophisticated econometric analysis to estimate.


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