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The federal government should consider reforms to capital gains tax rules to support the growth of innovative Canadian companies, says a new report from the C.D. Howe Institute.

The Toronto-based think tank’s report argues that the existing tax regime creates a “powerful disincentive” for private equity investors to exit through public markets. And, it says, the depth of Canadian equity markets needs to be enhanced “to allow firms to reduce their reliance on foreign investors and improve the chance of remaining independent.”

To that end, it suggests policymakers should look at adopting a tax policy measure, similar to the U.S. approach, “which provides for full exemption from federal taxation of capital gains realized on the sale of the shares of certain small businesses.”

Additionally, it recommends that the government consider “reducing the capital gains tax on shares issued by qualified [small- and medium-sized enterprises (SMEs)] when they list on a Canadian stock exchange and are held by individual investors for a reasonable period of time, since evidence suggests that capital gains taxes influence the underpricing of IPOs.”

Given public and private equity markets’ complementary role, government policy should support both and not impede growth when Canadian companies become public, said Pierre Lortie, senior business advisor at Dentons Canada LLP and author of the report.

Read the full report here.