Capital gains tax changes could lead to 'brain drain,' harm productivity as some fear tech exodus

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The Liberal government’s plan to increase capital gains tax for corporations and wealthier individuals is coming under fire from business leaders in the tech industry who say the policy rolled out in Tuesday’s budget creates a major disincentive for innovative companies to put down roots in Canada and will hurt the country’s already lagging productivity.

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Finance Minister Chrystia Freeland laid out plans for the inclusion rate on all annual capital gains for corporations and trusts — as well as capital gains above $250,000 for individuals — to rise to two-thirds from one half through amendments to the Income Tax Act, effective June 25, 2024. 

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John Ruffolo, managing partner of Maverix Private Equity and founder of OMERS Ventures, said there may be several unintended consequences of the tax changes, including scores of innovators leaving Canada.

“The job and wealth creators in this country are the scale-ups, which would hopefully far exceed the caps,” he said, adding that the tax change is also likely to result in a decrease in capital available in Canada to invest in funds and innovators.

Ruffolo predicted a dire outcome.

“The very folks who drive productivity and innovation will leave the country and head to the U.S. to build their businesses there,” he said.

The very folks who drive productivity and innovation will leave the country and head to the U.S. to build their businesses there

John Ruffolo

The problem, critics suggest, is two-fold. Innovators looking to build businesses will have less access to capital because their benefactors — businesses, trusts and individuals — will lose some of the money they would invest to higher taxes.

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Then, if a startup is successful, much of the initial founders’ gains, which are captured via equity, will be taxed away when the time comes to sell.

Economists at Toronto-Dominion Bank said the federal government partially offset negative impacts of the capital gains changes by raising lifetime capital gains exemptions as well as introducing a progressive, graduated rate for entrepreneurs — but they concluded this doesn’t go far enough to remove a disincentive to do business in Canada.

“A higher tax on divestment could very well be the straw that breaks the camel’s back and pushes that new firm elsewhere in a globally competitive environment,” wrote the group, led by chief economist Beata Caranci, in report published following Tuesday’s budget.

“In our current economic environment, it is at best unhelpful in promoting capital investment that Canada desperately needs.”

Entrepreneurs are not looking to sacrifice everything to make $250,000 — their dreams are much more ambitious than that

Adam Felesky

Some private equity and venture players said the tax changes will also make it difficult to attract skilled tech workers to Canada, something that is already a challenge.

“Brain drain will re-emerge,” said Adam Felesky, co-founder and CEO of Portage, a global investment platform focused on fintech and financial services, who concurred with others that the tax changes create a disincentive for innovators to set up their businesses in Canada.

“Entrepreneurs are not looking to sacrifice everything to make $250,000 — their dreams are much more ambitious than that,” he said.

“Why not start in a more favourable jurisdiction from the get-go?”

He said a typical entrepreneur would face a 33 per cent tax increase once they breached the $250,000 cap as a result of budget’s increase in the capital gains inclusion rate. He based his estimate on a tax bill of $33 per $100 of gains for someone in a 50 per cent tax bracket, compared to the $25 they would have paid when the inclusion rate was set at half rather than two-thirds of the capital gain.

Tobi Lutke, founder and CEO of Shopify, one of Canada’s largest and most successful tech firms, reposted a handful of messages critical of the tax change on X (formerly Twitter) after the budget was released. He topped one post with the words “Message from a friend” and followed that with: “Canada has heard rumors about innovation and is determined to will leave no stone unturned in deterring it.”

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The TD report took aim at Canada’s lagging productivity — a calculation measuring how much GDP is generated per hour worked —  and blamed the problems, in part, on a lack of investment in intellectual property. 

“Canada’s productivity has been abysmal,” the report said, noting that it has grown just 0.3 per cent since 2019 compared to the 1.5 per cent growth in U.S. productivity.

“Low investment is a huge problem. Intellectual property investment as a share of GDP is three times larger in the U.S.”

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Last month, Bank of Canada senior deputy governor Carolyn Rogers said the country is facing a productivity “emergency” and urged policymakers to tackle weak productivity to inoculate the economy against factors that will drive future inflation, such as a pullback from globalization.

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