Tax cuts or a tax hike?

Finance Minister Jim Flaherty has promised to deliver on most of the promises made during the Conservative election campaign when he hands down the federal budget next Tuesday. If this is true, it’s good news for charities and for clients who want to make donations of stock and securities.

Flaherty has re-iterated a pledge to reduce the GST by one percentage point as soon as possible. But that’s about the only thing budget watchers agree is a certainty.

Last fall, the Liberals reduced the personal income tax for those in the lowest bracket to 15%, from 16%. The Tories said they would reverse that decision, but experts say that won’t be easy, or popular.

Jamie Golombek, vice president of tax and estate planning at AIM Trimark, says payroll tables are currently using the 15% rate. If that’s increased to 16%, retroactive to the beginning of the year, companies will need to overcompensate when new payroll tables come out in July. That means taxes could be raised to 17% for the remainder of the year to make up for the lower rates used during the first half of the year.

“That’s the big question I have right now — how will the Tories specifically address the Liberal’s proposed tax cuts? Will they reverse them as promised or will they succumb to the pressure and keep them. That’s a wild card.”

Another question is whether or not the Tories will follow through on plans to defer capital gains taxes, if the proceeds are reinvested within six months.

Experts say this particular change is a lot more complex than it looks and will likely take considerably more time to put in place. In addition, the costs will likely exceed estimates outlined in the Tories’ fiscal plan.

“There are complications as to how this would be implemented and how it would be tracked, both by the government and by individuals,” says Golombek. “This is something that requires further study. I think we’ll see a more watered down version than a general capital gains exclusion and I think there’ll be limits that are put on this and rules as to what qualities or doesn’t qualify. I think it’s unlikely we’ll see any of this before the end of 2006.”

The C.D. Howe Institute released its “shadow budget” for 2006 on Wednesday, supporting both the GST cut and the Liberal’s personal income tax reduction, but suggesting that the Tories take another look at the capital gains tax promise. C.D. Howe says Tax Prepaid Savings Plans, Capital Gains Deferral Accounts, or providing additional capital gains contribution room for RRSPs are all options which offer deferral treatment for unrealized capital gains. “None of them requires fundamental changes to the existing capital gains tax mechanisms, or new valuation dates or income-inclusion rates.”

It’s also believed that the feds will likely stop taxing capital gains tax on listed stocks that are donated to charities. The promise is supported by all opposition parties; the only question is whether or not the budget will make the move retroactive to the beginning of the year. As it stands now, many clients with large donations appear to be waiting in the wings for clarification of the issue.

“My understanding, having spoken to people across Canada is that major donations are being withheld this year,” Golombek says. “People are holding off on making those donations because they fear that if they make that donation and then the new legislation comes down as promised, it might not be retroactive. I think that there’s a real waiting game going on right now between major gift givers, donors and registered charities in Canada. I think we need some certainty here. It’s really dampening donation efforts so far.”

The tax advantages for clients who make donations of appreciated stock are significant if the proposed changes are passed by the government. For example, if a client paid $40 for shares that are now worth $50, they could donate the appreciated shares for a $50 tax credit. Currently, 25% of that $10 gain is subject to tax.

In a special report on the subject, TD chief economist Don Drummond noted that exempting capital gains from taxation should unleash a new flood of donations and would likely cause a shift in the distribution of donations away from cash, toward stocks.

“Proponents of the measure have argued that donations of stocks could rise by 50% in response,” writes Drummond. “TD Economics believes that once people understand how attractive the measure is, the impact will be much greater.”

When clients and corporations were first allowed to donate securities and required to include only one-half of the capital gains realized, gifts of publicly traded securities jumped from $69.1 million to more than $200 million. “The $200.3 million of security gifts pales against the $1.3 trillion market value of stocks held by Canadians. Unrealized capital gains account for almost half of these holdings. Exemption capital gains from taxation should unlock more of these security holdings.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com