The Canadian government released updated draft legislation on August 4, 2023 to introduce a new 2% tax on certain equity repurchases starting January 1, 2024. In general terms, the tax applies to net repurchases1 of Canadian public company shares in excess of $1 Million. There are some exceptions. For example, mutual fund corporations are excluded from this tax. Certain reorganizations and repurchases of preferred shares that satisfy specific criteria are also excluded from this tax. For a review of these new rules, see our previous article, "The proposed new tax on share buybacks". The focus of this article is the stated policy behind the introduction of these rules.
In general and if correctly implemented, a corporation that distributes profits to shareholders has determined that more value will be provided to shareholders by such distribution than by using the profits in its business. In other words, when re-investing profits in the business provides less value to shareholders than distributing profits, an efficient (and arguably proper) use of capital is to distribute the profits to shareholders. There are generally two mechanisms by which a corporation distributes profits to its shareholders. The first is by paying a dividend. The second is by repurchasing shares.
When done properly and provided all those involved are fully informed, share repurchases benefit all shareholders. Share repurchases benefit the shareholders who wish to exchange their shares for cash. Share repurchases also benefit the other shareholders who do not wish to have their shares repurchased by increasing their proportionate interest in the corporation. However, not all share repurchases are done for sound business reasons and some are done for improper purposes such as artificially increasing share prices. Such repurchases can be aptly described as "stupid and immoral but otherwise fine."2
The United States introduced a tax similar to the Canadian tax on equity repurchases as part of the Inflation Reduction Act of 2022. Detractors of stock buy-backs have faced some harsh criticism. For example, Warren Buffett had the following to say regarding share repurchases: "When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive)."3
Part of the Canadian government's stated reasons for the introduction of the new tax on equity repurchases is to "encourage firms to re-invest in their workers and businesses."4 The 2022 Fall Economic Statement worded this slightly differently as: "While buying back shares is one legitimate way that corporations can return value to their shareholders, it can also divert corporate resources away from making investments in their workers and businesses in Canada."5 Either way you say it, could the government's stated policy objective encourage businesses to use capital inefficiently? Capital being deployed efficiently is important to a healthy economy and functioning market system. Consider for example a horseshoe manufacturing business at the time when the first farm tractor was introduced. Should government policy encourage reinvestment in the horseshoe business through its taxation policy or should capital be permitted to be efficiently returned to the shareholders of the horseshoe manufacturing business through a share repurchase?
Footnotes
1 The term "net repurchases" in general terms means repurchases of equity minus equity issued in a particular year.
2 Charlie Munger, Berkshire Hathaway annual general meeting, circa. 2010-2015 (paraphrase).
3 Warren Buffet, 2022 Annual Letter to Berkshire Hathaway Shareholders, at p. 6 para. 6.
4 Government of Canada, Department of Finance, A Made‑in‑Canada Plan: Strong Middle Class, Affordable Economy, Healthy Future (2023), .
5 Government of Canada, Department of Finance, 2020 Fall Economic Statement (2020),
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