Finance Minister Chrystia Freeland takes part in a TV interview after tabling the budget on Parliament Hill in Ottawa, on April 16, 2024.Justin Tang/The Canadian Press
Duncan Rowland is the founder and CEO of Migrations.ml, a Toronto-based capital markets startup.
This isn’t going to be a popular take, but I don’t think that the sky is going to fall as a result of the capital gains inclusion-rate increase, as announced in the federal budget last week. People don’t start companies because of the capital gains inclusion rate: They want to solve a problem, or build a great product.
Capital gains are profits made from selling assets, such as stocks or property. Last week, Ottawa raised the amount that would be taxable. For businesses, and for individuals beyond a certain threshold, 67 per cent of capital gains would be subject to taxes, up from 50 per cent. Critics have said this would deter business investment, particularly for startups.
But when the reverse happened, when the inclusion rate was cut from to 50 per cent from 75 per cent in 1999, I don’t recall there being a wave of new companies created, and frankly if the inclusion rate today was cut to 25 per cent from 50 per cent, I don’t think there would be a wave of new companies or new investors.
I’m old enough to remember when the Land Transfer Tax was rolled out in Toronto: Doomsayers said it would kill the housing market, but it didn’t. People still wanted to live in Toronto, and would pay almost any price to do so.
Similarly, the “demand” side of starting a company is inelastic in the context of tax rates. People who have an idea that gnaws at them, or are bored, or feel underpaid, or a combination of these, will start a company rather than be a drone. Anyone who tells you “I would have started a company, but then the capital gains rate was increased,” is full of it and looking for excuses.
Even in the United States, where there is a huge US$10-million tax exemption on capital gains for a company founder, from conversations with my American counterparts, this isn’t the impetus for starting a company.
I also find it dubious that investors are suddenly going to run away from the startup space.
A venture capital company investing in startups has to raise funds itself and promise its own investors outsized returns. Those investors are typically sophisticated individuals or companies that have investments across fixed income, equities and other asset classes. They will be dealing with the higher inclusion rate on all of their investments, not just venture capital, so there is no loss of comparative advantage for their allocation to VC.
The VC firm aims to score a big gain on 10 to 20 per cent of the companies in their portfolio, to offset the eventual writeoffs of the other 80 to 90 per cent. Most Canadian VCs don’t invest in prerevenue startups, so when they actually write a cheque for a company, there are high expectations of a return of 10 times or greater. If they think that a business is going to experience exponential growth, would they really elect not to invest, because now they’re going to get slightly less money from an exit?
Can you imagine the VC portfolio manager telling their investors: “Sure, we could have made $10-million from this investment, but by not investing, I helped us avoid paying an extra $700,000 in tax!”
In the movie The Social Network, the Sean Parker character says, “You know what’s cool, a billion-dollar idea.” In the startup world, we’re all chasing that billion-dollar idea, and the billion dollars that comes with it. With this change in the inclusion rate, a billion-dollar idea is still worth a billion dollars. Canadian entrepreneurs are still going to pursue it, and Canadian investors are still going to search for it.
If a Canadian founder gets her funding from the United States, it’s probably because that American investor had a greater risk appetite and was willing to offer a better deal. If she had to relocate to the New York, San Francisco or London because that’s where the money and clients are, then she’s a smart business person, and the inclusion rate was again a non-factor in that decision.
Those locations have ecosystems with deeper and more diverse sources of funds, more experienced advisers, bigger pools of clients, and a community for networking and sharing ideas. An early-stage startup is going to leverage those advantages in pursuit of top-line revenue growth, a later-stage startup will leverage them to scale its operations. A capital gains inclusion rate has no impact on either of those goals.
U.S. Supreme Court justice Oliver Wendell Holmes said nearly a century ago: “Taxes are what we pay for a civilized society.” This holds true today, so I’d prefer to see less hysteria, and more consideration that something has to be done to reduce homelessness and make housing affordable for the next generation.