Analysis has been published that suggests that the Conservative Party election promise of removing capital gains tax on reinvested capital. Some say it is a policy that will remove the tax deferral advantages of registered retirement savings accounts. It might also make some income trusts more attractive.

The policy proposition is that capital gains tax will be removed if the cash from capital with gains is reinvested within 6 months of the sale that triggered the gain.  Although there has been no details presented on exactly how the policy would be administered.

Current analysis by tax policy experts and plain old logic suggests that such a shift in tax would do the following:

(1) Provide new advantages to those investors who invest outside a registered account;

(2) Defer gains in non-registered investment accounts until cash is removed, so making cash accounts a lot like registered retirement accounts (RRSPs or RRIFs) in terms of equity holdings (but not securities that produce business or interest income, for example):

(3) Protect active traders from tax;

(4) Delay tax on distribution income for those investors who hold income trusts that distribute cash treated by Canada Revenue as return of capital or capital gains;

(5) If applied to corporate capital gains tax, then this exemptoin takes away barriers for companies converting into income trusts.  Many companies that have never paid tax that then convert into a trust pay large gains tax at the time of conversion.

Various estimates consider how much tax “loss” the policy will cost government tax coffers. The Conservatives say it may cost $750 million in lost or deferred tax over the first five years. At the other end of the spectrum, the Liberal Party estimated that more than $8 billion will be lost or deferred.  Independent analysis varies across the spectrum while the Department of Finance is reported to estimate the cost of tax deferral more in the range of $2 billion or so.

It reminds us that the system is complex. It�s a challenge to put together useful data to define meaningful questions let along find real tax answers. It reminds us of the debates about tax triggered by the Department of Finance Consultation Paper on Flow-through Entities and Income Trusts, published at the end of 2005 under the direction of a Liberal government.

Whatever the final number on Conservative policy, such a deferral of capital gains will provide advantage to a few placed people.  In the near term, the most advantage will go to those who are heavily invested in the market already, particularly those with big capital gains made in the last year.  Some of those investors include income trust investors who participated in the fast-growing market and price gains in recent years.

Whether we like it or not, the most gains go to those who are capital rich and to sophisticated traders.  Large funds and wealthy individuals will be more likely to keep their money in Canada rather than choose, like some do, to move their investments and our tax base into off-shore accounts in tax-free zones.

If investors� holdings match market averages, then income trust investors will gain a lot without capital gains tax when they hold their trusts in regular cash or trading accounts.  Our iTrustReport indicated that if investors bought income trusts on the day of first issue, those securities provided on average an annualized total return of 38% as of mid-2005. That annualized gain was made up of 30% in capital gains and 8% in annual average rates of distribution. So the sophisticated TrustInvestor should quite pleased with Conservative tax policy in some regard.

A majority of Canadians might lose or gain less from the Conservative taxation proposal:

(1) People who racked up capital losses in the early 2000’s by having bought into the hype of the technology bubble and mutual funds, before their collapse, i.e. people with capital losses carried forward on their tax account for application to future gains;

(2) Mutual fund investors including a majority of Canadian investors, depending on how the Conservative policy is defined or applied;

(3) Small investors and others who put equities into their RRSPs because this large group of people will not have the flexibility to manage their money in that account without tax as much as others who invest outside the registered savings account.

If we look at big implications versus small investor realities, there are key questions to consider: What about businesses like speculative commodity trading houses that make huge capital gains?  Will corporations be given the same tax advantage as individuals?

In effect, a capital and reinvestment-oriented tax policy can generally be seen as equity and trade-oriented in the way it conditions the market to spread favorable returns.  Conservative policy might be seen as very much a product of our time in the era of increasingly rapid trade across inter-connected global financial markets.

The policy might bring Canadian investors into the new age with advantages available to others around the world. But without other new policies to coordinate and integrate the tax system at home, there can be problems. As we’ve seen with major financial market failures in the last decade, rapid global financial trade—particularly in an interconnected world and intangible, derivative-tempered world—opens the flood gates to rampant speculation and global financial risk like we’ve not seen before in human history.

The Canadian tax system might benefit form an overhaul.  But thoughtful integration and coordinated policy is required.  The Liberal Party has been accused of market-meddling and worse in terms of its tax policy explorations in the realm of income trusts.

Is there a political party willing or capable of leading intelligent tax-related policy development? That’s still not very clear.