Tech industry leaders warn capital-gains measures will stymie entrepreneurship

Ottawa’s increase to capital-gains taxes will have a chilling effect on the innovation economy and impede investment and risk-taking, technology industry leaders said after the release of the federal budget this week.

The changes, they said, could discourage founders and tech workers from starting companies in Canada and deter venture funding by reducing the profits that investors can earn.

“The tech industry is viewing this budget as hostile,” Benjamin Bergen, president of the Council of Canadian Innovators, a technology industry group, said in an interview. “This shows a fundamental misunderstanding of how the innovation economy works. Ultimately, it will set our country back.” The group published an open letter Wednesday evening expressing opposition to the measures, with more than 150 signatures from some of Canada’s most prominent tech companies and investment funds.

Under the changes announced in Tuesday’s budget, businesses will pay income taxes on two-thirds of their earnings from capital gains each year, up from one-half. The same increase applies to individuals, but only on capital gains in excess of $250,000. The government has said these measures, effective June 25, 2024, will add $19.4-billion to its coffers over five years.

The move will affect people who sell assets for profit, including those who sell their businesses, convert stock options to common shares or take their businesses public.

The budget measures are arriving at “the worst possible time,” said Kim Furlong, chief executive officer of the Canadian Venture Capital and Private Equity Association. Interest rates are still high, she noted, and mergers, acquisitions and initial public offerings have slowed.

“The impact on investors and entrepreneurs is direct, but the impact will reverberate through the whole economy. This strongly signals that risk-taking is not encouraged,” she said.

Many tech workers in early-stage startups take on risk for the potential of future reward, including capital gains when a company goes public. Targeting that value could send the message that the risk might not be worth it, Mr. Bergen said.

Tech executives aired their disapproval of the new measures on social media.

“At a time when our country is facing critically low productivity and business investment, our political leaders are failing our country’s entrepreneurs,” Shopify Inc. president Harley Finkelstein wrote in a post on X.

Marie Chevrier Schwartz, founder and chief executive officer of the product sampling company Sampler, called the budget measures shortsighted in a LinkedIn post. “How are we going to encourage innovation, job creation or strong economic performance if we’re not encouraging folks to dream?” she wrote.

Budget’s capital gains tax changes divide the small business community

Tuesday’s budget also included some measures apparently designed to blunt the impact of the tax increase. Ottawa introduced a Canadian Entrepreneurs’ Incentive, which will reduce the taxable portion of capital gains to 33 per cent for entrepreneurs in certain industries, on a lifetime maximum of $2-million in eligible earnings. The technology sector did not appear on a list of industries that will not be allowed to take advantage of the reduction.

This is on top of the existing lifetime capital-gains exemption on the sale of small businesses, which the government raised from $1-million to $1.25-million, meaning some entrepreneurs will have a combined exemption of at least $3.25-million when selling all or part of a business.

Dan Kelly, president of the Canadian Federation of Independent Business, said that while most small-business owners will come out ahead or be unaffected by the capital gains changes, the measures could deter small companies from aggressively pursuing growth.

David Shipley, chief executive of the cybersecurity company Beauceron Security, said he would likely have sold his business two years ago instead of growing it if the new conditions had been in effect then.

Mr. Shipley took issue with one particular requirement for claiming the Canadian Entrepreneurs’ Incentive: a company’s founder must own at least 10 per cent of the shares in their business. He said matters of ownership should be out of the government’s control.

Bruce Croxon, co-founder of venture capital firm Round 13 Capital, called the new measures “demoralizing, depressing, and disincentivizing.” He added that they will dampen investors’ willingness to take risks in Canada, given the lower potential reward.

“It’s a global economy. We’re facing the reality that people will choose to put their money elsewhere,” he said.

Jason Smith, chief executive officer and founder of Vancouver software company Klue Labs, warned that the measures could push Canadians to start their companies outside Canada.

“Canadians teeter on edge on starting their companies in Canada or going to the U.S.” he said. “Every incremental tax makes us think twice about starting companies in Canada.”

Some defended the capital-gains tax hike. In a report for law firm Osler, Hoskin & Harcourt, Stephen Poloz, a former governor of the Bank of Canada, said the higher taxes will be necessary to cover higher expenses for health care and the military.

“Some will lament the need to raise taxes, for higher taxes arguably frustrate economic growth and productivity. However, this government has made some permanent changes that will cost money forever,” Mr. Poloz said. “No other route is fiscally responsible.”

The capital gains changes overshadowed other technology and innovation-related announcements.

The government had recently announced $2.4-billion to support the artificial intelligence industry, but has not provided further detail about how that rollout will occur.

The budget also allocated $1.8-billion over five years to three federal research councils, $600-million for the Scientific Research and Experimental Development tax incentive program, as well as $200-million for the Venture Capital Catalyst Initiative, a government investment program.