Taxing Unrealized Gains Is A Silly Idea That Canada Should Ignore

Let’s pretend your boss promises you a big raise and a bonus, but you won’t actually receive either for 24 months. Now, imagine the government taxes you on that promise today.

Say the raise and bonus will eventually total $50,000. Even though you won’t see a dollar of it until two years from now, you must report the full amount on your current tax return. At an assumed 30 per cent tax rate, that means paying $15,000 well before you ever receive the money. What happens if your employer reneges on the promise? Shouldn’t you get your tax back?

Sound absurd? It is.

Modern income tax systems are built on a basic premise: you are taxed when you realize an economic gain, not when someone predicts you might receive one. Income must be measurable. It must be real. And it must be liquid, or at least presumed to be. The Haig-Simons theory of income would tax annual changes in net worth, but most countries sensibly favour realization to preserve liquidity, certainty and stability.

There are obvious exceptions to these goalposts, such as various taxation regimes on death and exit tax regimes when people are no longer subject to the taxing regime of a country because of loss of residency (or in the United States, renouncing one’s citizenship ).

Wealth tax regimes — which are rare — are another exception and despite many lefties advocating for wealth taxes to solve society’s many problems, they are very ineffective because of their non-adherence to the basic pillars.

Many countries also have deemed income inclusions for certain types of income to prevent targeted abuse or avoidance. For example, New Zealand, through its foreign investment fund rules , and Canada, through its foreign investment entity and foreign accrual property income rules, impute annual income for certain types of foreign investments held by residents. Most countries have similar anti-avoidance rules that target otherwise available tax deferral.

Beyond the above exceptions, eyebrows are raised when tax proposals are put forward that challenge the basic pillars. Last Thursday, the Dutch House of Representatives voted to pass a proposal that, simplified, will tax Dutch residents at 36 per cent on actual investment returns, including unrealized gains on stocks, bonds and cryptocurrencies.

Certain types of assets, such as real estate and qualifying startups, will follow the normally accepted model whereby tax is only imposed when such assets are disposed of. The proposal still needs to pass the Dutch Senate, but if it does, it will be effective Jan. 1, 2028.

In a simple example, if a Dutch resident owns, say, Apple Inc. stock and it has increased in value by 50,000 euros over the year, but the resident still holds the stock in his portfolio, the Dutch tax authority will treat that amount as taxable income and impose a 36 per cent tax, subject to some minor adjustments.

What about future losses, analogous to the example above where the employer reneges on paying the promised amounts? Can they be carried back to the years where there were gains to recover taxes paid? It doesn’t appear so. Losses will be carried forward, not back. Ouch.

The Dutch proposal appears to be a replacement for a system that used to impute income — using a fictitious/assumed rate of return — on savings and investments held by residents that ignored actual returns. However, the Dutch Supreme Court said that system was unconstitutional.

If the new Dutch proposal sounds familiar, it is. Many policymakers have suggested taxing unrealized gains. U.S. presidential candidate Kamala Harris proposed something similar in 2024 for ultra-wealthy people. It was rightly and widely criticized. Like the California ballot initiative to tax billionaires, these types of proposals are problematic, given the mismatch between an economic event and the imposition of the tax.

That said, there is a legitimate argument that the tax system should respond when an investor monetizes appreciated stock through structured borrowing or securitization that converts unrealized gains into usable cash. Once liquidity is extracted, the realization principle is functionally met.

The Dutch proposals will cause obvious liquidity problems. With capital being mobile, many residents will explore ways to avoid such an unfair tax. Significant capital flight from the Netherlands will no doubt occur should the proposal pass.

But what about the Dutch people who cannot leave or have minimal capital — the so-called middle class? Will they be punished? Yes, because they are trapped within a system that punishes capital accumulation.

Will such a system ever be adopted by Canada? Never say never. Canada’s finances are in rough shape, so a day of reckoning will eventually come. Huge government spending with out-of-control deficits will need to be paid for. Additional taxes will be an inevitable result.

Back to the simple example at the beginning, taxing a promised raise before it is paid feels absurd because you haven’t received the money. It may never materialize, yet the tax is due anyway.

Income tax systems have long recognized this distinction. We tax salaries when paid, capital gains when realized and investment income when received. That discipline prevents volatility, valuation disputes and forced sales just to cover a tax bill.

The Dutch proposal crosses a much broader line. If enacted, the Netherlands will become one of the first major economies to broadly impose annual taxation on unrealized gains for ordinary investors.

Canada should watch with caution. Our fiscal pressures are real, but drifting toward politically fashionable experiments that abandon realization-based taxation would inject instability into an already complex system.

• Ottawa should just cut the rate and offer one big credit
• The new GST breaks are a bad idea that we'll all pay for in the end

Promises are not paycheques and paper gains are not income.

As economist Adam Smith observed more than 200 years ago, “The tax which each individual is bound to pay ought to be certain and not arbitrary.” Realization-based taxation respects that principle; unrealized taxation does not.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody.

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