Read: André L’Espérance’s column Increasing estate value for the affluent
Will estate taxes come back to Canada? They are certainly in the spotlight.
The estate tax debate lurches back and forth in the U.S., as the legacy of the tax package enacted by the Bush administration in 2001 – with a sunset clause allowing the cuts to expire by 2010 – is contested. In the interim, the Obama administration has applied a patch to keep most of the cuts in effect until 2013.
Still, U.S. debates have little effect on Canadian tax policy, suggests Jack Mintz, the Palmer Chair in Public Policy at the University of Calgary. As he pointed out to the annual conference of the Society of Tax and Estate Practitioners (STEP) in Toronto earlier this week, the Canadian and U.S. tax systems are quite different.
For one thing, Canada hasn’t had an estate tax since 1972; that’s at the federal level. Most provinces followed the federal lead quite quickly and eliminated their own estate taxes, except for Quebec. But, with the demise of the estate tax came capital gains taxation, and importantly, deemed disposition of capital assets on death.
Estate taxes are one member of a grouping of wealth transfer taxes. There are three forms: estate taxes proper, where the estate pays the taxes; inheritance taxes which Mintz suggests are slightly more progressive, in that the heirs are taxed on their differential wealth. A third, more complicated scheme is called accession, whereby each wealth transfer, whether through inheritance or gifts, is taxed.
There are also some backdoor – or indirect – wealth transfer taxes, such as probate fees and land transfer taxes.
The U.S. has, alongside an estate tax, a gift tax – otherwise property transfers could escape estate taxes, by making a “gratuitous” transfer. What is meant by that is the recipient of the gift paid nothing for it – even though the transfer might involve a reduction of taxable liability by the person who makes the gift.
Wealth transfer tax schemes vary in complexity. There may be good reasons to have them, says Mintz, to reduce economic inequality or to promote tax efficiency or simplicity.
On the economic equality front, “the primary role of estate taxes is to reduce inequality in society when wealth accumulates in a few hands,” he says. Also, he notes, “from the point of view of ability to pay, it’s easier for the rich to pay than those who don’t get much of an inheritance.”
However, wealth transfer taxes could give rise to tax-arbitrage schemes; and the simplicity is often vitiated by the administrative costs of levying the tax.
Even then, such taxes don’t raise very much revenue. On average, in OECD countries, the proportion of wealth tax revenue to the total tax take is 0.41%. In the U.S., where the estate tax is highly contested, it is 0.8%.
There is a reason for low tax take, and it has to do with exemptions. It’s not just what level of wealth transfer is taxable – what the threshold is before the tax kicks in, currently $5 million in the U.S. – but what counts as wealth. For political reasons, Mintz notes, much of what would conventionally be considered wealth is not taxed at all. That includes principal residences, farm properties, small businesses assets, charities and so on.
That also applies in Canada, but there are significant exemptions. Like a few other countries, Canada has a deemed disposition regime. On death, all capital property is taxed at its fair market value. The result is a capital gains tax for the estate.
It doesn’t tax total wealth transfers, but only the increase in value. But, Mintz notes, the U.S. has resisted similar deemed disposition rules, even though the capital gains rate is much lower in the U.S. – at 15% – than it is in Canada, where 50% of capital gains are taxable as income.
Canada could, hypothetically, implement a kind of wealth tax, by adding a surtax on deemed dispositions larger than $25 million. “Certainly there are ways of doing wealth transfer taxes in Canada that would not be another estate tax,” he explains.
Still, Canada has moved over the years to spare savings from taxation – in order to encourage investment – while taxing consumption. The GST/HST was part of it. So was the introduction of Tax-Free Savings Accounts.
That makes for two interesting wrinkles. Bequests to children, or others, could be considered a form of consumption, Mintz argues.
Secondly, as tax preferences for savings decrease the tax base, there could be pressure down the road to institute some form of wealth transfer tax.