Catherine (Cathie) Brayley, Miller Thomson LLP, Vancouver
Lesley Kim, Gowling WLG, Calgary

January 1, 2022 marks the 50th anniversary of the capital gains tax in Canada. In this article, we outline the history of capital gains taxation in Canada, describe some of the key features of the current system, and comment on potential reforms.

An Overall Review of the Tax System: Capital Gains To Be Taxed

The origin of capital gains taxation in Canada can be traced to the Carter commission, appointed in September 1962 to thoroughly review the Canadian tax system. Extensive debate ensued. In 1966, the commission's report recommended, among other things, that a tax be imposed on capital gains. The commission acknowledged that the taxation of capital gains would be a "radical reform" of the Canadian tax system. Its rationale was that capital gains should be taxed in the same manner as other sources of income, such as employment income, rent, dividends, and interest. The commission's views in this regard have often been summarized as "a buck is a buck is a buck."

Three years later, the government published a white paper setting out definitive proposals for, among other things, the imposition of a capital gains tax. The 1969 white paper proposed that all or a portion of capital gains realized by a taxpayer, depending on the nature of the asset, would be included in income and taxed at the taxpayer's marginal rate. This would increase the portion of the wealthy individuals' total income that is taxed. The tax system would become more progressive, and the high rates of income tax imposed at that time (80 percent, not including the federal surtax and provincial income tax) would no longer be needed for a fair system. To ensure that gains accrued before the new tax system was introduced would not be taxed, a valuation day (V-day) concept would be introduced. The government recognized that the proposal to tax capital gains was (in the words of the white paper) a "major and controversial step," but it concluded that "the step must be taken if Canada's tax system is to be fair, and if it is to be effective."

The white paper proposals included the following key features:

  1. Only 50 percent of capital gains realized in respect of shares of widely held corporations would be included in income upon disposition.
  2. One hundred percent of capital gains realized on other capital property, such as private company shares and real estate, would be included in income upon disposition.
  3. Shares in widely held companies would be revalued on the basis of the market every five years, and tax imposed on any accrued capital gain.
  4. Gains realized on dispositions of principal residences and property owned for personal use would generally be exempt, subject to some limits.

After considerable debate, on January 1, 1972—almost 10 years after the appointment of the Carter commission—capital gains became taxable in Canada.

Inclusion Rate: The History

The Carter commission took the view that property income should be taxed in full as ordinary income since "preferential rates produce complexity and a lack of neutrality." The government, however, rejected the view that any increase in economic power, regardless of the source, should be treated the same way for tax purposes. It opted to impose capital gains taxes only on an actual or deemed disposition rather than on a mark-to-market basis, and it decided that, contrary to the recommendations of both the Carter commission report and the 1969 white paper, only 50 percent of capital gains (whether on publicly traded shares or other capital property) would be subject to tax, starting in 1972. To ensure appropriate grandfathering, capital gains accrued before 1972 were exempt by means of a V-day mechanism.

The 50 percent inclusion rate was the result of significant deliberation and compromise. As Strain, Dodge, and Peters observed, in a 1988 CTF conference report paper on tax simplification:

Strong arguments were advanced that the full taxation of capital gains would inhibit economic growth. The need for an adequate level of capital formation, the desirability of encouraging a continued supply of risk capital, the encouragement of equity investment and healthy capital markets, and the need to adjust for inflation in measuring real capital gains were all seen to be important issues.

In the 1971 federal budget speech, Finance Minister E.J. Benson found it noteworthy that the 50 percent inclusion rate for capital gains would match the United States' rate.

The 50 percent inclusion rate remained in place until the late 1980s. On June 18, 1987, Finance Minister Michael Wilson announced that the rate would increase to 662⁄3 percent in 1988 and to 75 percent in 1990. The new reforms, unlike the 1972 reforms, provided no grandfathering for gains accrued under the old regime. The 75 percent inclusion rate continued through the 1990s until February 27, 2000, when it was reduced to 662⁄3 percent. In the 2000 fall economic statement, the inclusion rate was further reduced to 50 percent, and that rate has continued to the present day.

At the current 50 percent inclusion rate for capital gains, the rate on capital gains is approximately 11.5-13 percent for corporations (plus 102⁄3 percent refundable tax for Canadian-controlled private corporations) and 24-27 percent for individuals at the highest marginal rate (depending on the province).

When Is a Capital Gain Subject to Tax?

In keeping with the realization principle, capital gains are generally taxed only at the time of disposition of the relevant capital property. They are generally not taxed as they accrue. Taxpayers may defer the taxation of unrealized gains until the time of actual or deemed disposition.

In some circumstances, capital property is deemed to have been disposed of at fair market value (FMV). Such circumstances include the death of an individual taxpayer, a taxpayer's immigration to or emigration from Canada, and a situation where the use of a property has changed—for example, from an income-producing to a non-income-producing property, or vice versa. In addition, inter vivos trusts are generally deemed to have disposed of their property every 21 years, thereby limiting deferral opportunities. When a disposition of capital property is made by way of a gift or disposed to a non-arm's-length party, the property is normally deemed to have been disposed of for FMV proceeds.

One-half of capital losses can be deducted, but only against taxable capital gains. Unused capital losses can generally be carried back three years and carried forward indefinitely, but they may be deducted only against capital gains.

Lifetime Capital Gains Exemption

In the May 1985 budget papers, the government introduced the LCGE for individuals, a measure that would have exempted all gains up to a lifetime limit of $500,000. The government's stated goals were to (1) encourage risk taking in small and large businesses; (2) assist farmers; (3) improve the financial health and balance sheets of Canadian companies; (4) provide a tax environment conducive to technology companies raising capital; and (5) encourage Canadians to start businesses. The exemption was to be cumulative, available to offset capital gains realized throughout an individual's lifetime.

The LCGE was to apply to all capital property and be phased in over six years. Just two years later, however, in 1987, the government reversed course and, as set out in the 1987 white paper on tax reform, capped the LCGE at $100,000 for all capital property other than QSBC shares and qualified farm property.

The phasing-in of the LCGE was accelerated for QSBC shares, with the limit set at $500,000 in 1988. Under the 1994 federal budget plan, the more limited $100,000 LCGE was eliminated, with a grandfathering rule allowing individuals to increase the cost base of their investments up to FMV on the date of repeal in order to use the balance of the exemption available to them.

For QSBC shares, the $500,000 limit was subsequently indexed to inflation; as a result, the per-individual exemption amount for 2021 is $892,218. Where the shares are owned by a trust for the benefit of multiple individuals, the value of the LCGE can be enhanced because each beneficiary will be entitled to their own lifetime exemption.

Principal-Residence Exemption (PRE)

As recommended in the Carter commission's report, capital gains realized by individuals on the sale of principal residences are completely exempt from tax. The Carter commission justified this exemption partly on the basis of administrative ease. The 1969 white paper had rejected a full exemption, proposing instead a limited exemption ($1,000 per year of occupancy) on the profit from the sale of a principal residence. The government backtracked in 1971, however, and the legislation implemented a full PRE. The rules for claiming the PRE were tightened somewhat in 2016, requiring taxpayers to report the disposition of a principal residence, but the PRE has survived largely intact for almost 50 years. With the recent dramatic appreciation of owner-occupied housing in some urban markets, the PRE stands to permanently exempt substantial capital gains from taxation.

Donated Securities

Donations to registered charities give rise to a charitable tax credit for individuals and a deduction for corporations equal to the FMV of the gift. When the subject matter of the gift is publicly traded securities, no portion of the accrued gain is subject to tax. For private corporations, the full amount of the (tax-free) capital gain is added to the capital dividend account and can be distributed to a shareholder tax-free. The accrued capital gain on the donated securities is never taxed, which provides a valuable incentive to donate them.

No similar exemption is available for donations of other capital property, such as real estate or private company shares. One explanation for this could be the valuation challenges arising in respect of such property.

In the 2015 federal budget, the government proposed a capital gains exemption for the donation of proceeds from the sale of private shares or real estate to registered charities. It announced in the 2016 federal budget that it would not proceed with this measure.

The COVID-19 pandemic has adversely affected the ability of charities to raise funds for their charitable purposes, and this has triggered renewed calls for extending the favourable treatment of donated property. The House of Commons Standing Committee on Finance recommended in its February 2021 report (according to an article in Advisor's Edge published the same month) that the capital gains tax on donations of private company shares and real property to registered charities be eliminated. This recommendation was not implemented in the April 19, 2021 budget.

Comments on Some Potential Reforms

Some of the reasons for the past changes to the capital gains inclusion rate are relevant today. From the 1960s through the 1980s, the government needed additional sources of revenue. Today, there is a significant deficit because of the emergency measures introduced in response to COVID-19. It seems likely that the government will give serious consideration to changing the taxation of capital gains, including by an increase in the inclusion rate.

It was a study of the tax system in general that originally gave rise to a consideration of the taxation of capital gains and the appropriate inclusion rate for exemption. The changes in 1972 were the result of almost 10 years of study, consultation, and debate. The changes in 1987 were the result of four years of study. The tax system is complex. A significant change that will generate consequential changes should be considered in light of a review of the whole system, rather than in isolation.

In this issue's lead article, Robin Boadway states that the absence of an inheritance tax represents a source of windfall gains. An estate tax existed before 1972. It was abandoned because of the deemed realization of capital gains on death. If (for reasons of fairness, as Boadway suggests) an inheritance tax is introduced, reconsideration will have to be given to the taxation of accrued gains on death.

The Carter commission proposed an exemption from capital gains on the disposition of a principal residence. The 1969 white paper rejected that proposal and recommended an exemption of $1,000 per year of occupancy. The 1971 federal budget ultimately provided a full exemption. Given the steep recent rise in the value of residential properties, it would not be surprising if new limits are imposed on the PRE. The decision will be complicated. Factors to be considered include (1) whether the new regime should apply to values accumulated before the effective date; (2) whether a cap should be applied, which would affect the values of properties in some municipalities more than the values of properties in others; (3) whether relief should be available when a residential property is sold at a loss; and (4) whether an exemption should exist for residential properties that are included in a farming property.

COVID-19 has had serious consequences for charities that depend on charitable donations to fund their activities. It seems logical to expect that an extension of the favourable treatment of gains on donated property would tend to increase donations. Any valuation issues associated with donations of private company shares and real estate would be eliminated if the source of the donation was the proceeds from arm's-length sales of these properties. In this regard, the 2015 budget proposal may provide a workable solution.


The federal government's 1971 decision to include capital gains in income was part of a sweeping change to the Canadian income tax system. Over the years, the taxation of capital gains has been normalized. The notion that capital gains should form a part of the tax base has largely been accepted, both in Canada and globally. Although certain exemptions have changed, the inclusion rate has generally remained stable, with only a few ups and downs between 1988 and 2000. With the onset of COVID-19 and the extensive support measures that the government has implemented in response to the pandemic, many have begun to wonder whether changes are coming to the capital gains system, including an increase in the inclusion rate and the limits on the PRE. Today as in the past, the government's need to raise revenues is a key consideration. It remains to be seen whether there will be a significant change.

Originally Published by Canadian Tax Foundation, Perspectives on Tax Law and Policy.

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