Ottawa reveals plan for new tax on stock buybacks

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The federal government plans to impose a new tax on public companies that pursue share buybacks, a popular way to reward investors and reduce volatility, but one criticized by some politicians for diverting funds away from pressing goals such as the energy transition and domestic job creation.

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The tax plan, unveiled by Finance Minister Chrystia Freeland in her fall economic update Thursday, is to be fleshed out in the 2023 budget and come into force Jan 1, 2024. It is expected to increase federal revenues by $2.1 billion over five years.

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Freeland said the tax will be “similar” to the one-per-cent buyback tax in the Inflation Reduction Act signed into law by United States President Joe Biden in August.

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“We’re taxing share buybacks to make sure that large corporations pay their fair share, and to encourage them to reinvest their profits in workers and in Canada,” Freeland said in prepared remarks for the economic update.

“While buying back shares is one legitimate way that corporations can return value to their shareholders, it can also divert corporate resources away.”

Energy companies weren’t singled out, but recent share buybacks amid record profits from rising oil prices and inflation have drawn criticism from government.

Environment minister Steven Guilbeault, in particular, criticized oil companies earlier this month for returning money to shareholders while making limited investments in the energy transition.

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At a news conference Thursday, Freeland said she believes the share buyback tax is better than a “windfall” tax on energy companies, such as the ones imposed by the United Kingdom and European Union. Canada has imposed specific levies on financial institutions including banks and insurers, noting that government initiatives helped them remain profitable throughout the COVID-19 pandemic.

Freeland said she believes the share buyback tax announced is a “very appropriate step,” because it sets up an incentive for all public companies.

“What that tax does is it create an incentive to do precisely what we want to see big Canadian companies doing … taking their profits and investing them in the productive capacity of Canada,” she said.

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“It’s a smart tax. It will raise some money for Canada, which is a good thing. But perhaps even more importantly, it creates the right set of incentives for companies to do the right thing.”

Word of the planned share buyback tax leaked out before the economic update, and received a chilly reception from some business leaders and finance experts.

Speaking before the tax on corporate share buybacks was confirmed, Alex Gray, senior director of fiscal and financial services policy at the Canadian Chamber of Commerce, said the tax would limit “efficient” allocation of capital. He added that, in the chamber’s view, it would hinder Canadian businesses’ ongoing recovery from the economic consequences of the COVID-19 pandemic and as recession concerns mount.

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“As stock buybacks help improve stock liquidity while limiting stock volatility, such a proposal would ultimately increase economic uncertainly at an already precarious time,” he said.

“When higher volatility is expected, companies can increase their buyback intensity to stabilize stock prices, thereby enabling smoother trading and lowering transaction costs.”

Yrjõ Koskinen, a professor of finance at the University of Calgary’s Haskayne School of Business, said share buybacks are being “vilified” in public discussions even though it makes more sense to return funds to shareholders via buybacks and dividends than to invest in unprofitable projects.

“This applies to all companies, including energy,” he said.

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Moreover, Koskinen said that if Canada matches the one-per-cent buyback tax in the U.S., it probably wouldn’t change the calculus for energy companies that are unlikely to profit from transition investments in the short term.

“If investing in energy transition was unprofitable before the tax, it would also remain so after the tax,” he said. “So the tax on buybacks would be mostly a symbolic act with limited consequences.”

Koskinen said he thinks there should be accelerated investments in energy transition to address the risks of business as usual, but there are probably better ways than a new tax.

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“In order to foster long-term investments, it would be of utmost importance to create a stable regulatory and tax environment, so that companies dare to take the plunge,” he said. “To me, the tax on stock buybacks sounds more like a gimmick rather than a serious policy.”

Canadian energy investors recoiled from news of a potential tax on stock buybacks Thursday before the details were released.

Investors who have remained loyal to the oil and gas sector throughout the protracted downturn in energy prices that began in 2014 and continued through until the end of pandemic lockdowns are particularly furious at the prospect of a tax on profits just as shareholder returns have been climbing in the past 18 months.

While the impact of the measure will depend on the size of the tax, most energy investors reacting to the news Thursday were skeptical a tax on buybacks would trigger more spending from companies on operations and workers.

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Most energy firms enjoying sizable free cash flow will simply prioritize dividends, said Eric Nuttall, partner and portfolio manager at Ninepoint Partners LP.

“It’s pure idiocy. It will have absolutely zero ability to drive incremental investment as it’s coming from a government whose every action over the past numerous years has shown that they do not want incremental investment by the oil and gas industry. They do not want incremental production,” he said.

“The only thing that I view this as accomplishing is stealing much-deserved rewards from energy investors after having experienced the worst bear market in the history of the energy sector.”

In the fall economic update, Freeland also reiterated her government’s earlier pledges to introduce a new minimum tax regime for the wealthiest Canadians, and to implement a global minimum tax regime to ensure that large multinational corporations cannot avoid paying taxes, regardless of where they do business.

– with files from Meghan Potkins

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