handbook-tb

Taxation of non-residents’ capital gainsFrom the perspective of economic efficiency, it is in fact attractiveto tax many of the types of gain described above. Increases in thevalue of non-reproducible assets — land, natural resources and collectibles— tend to reflect what economists call “pure rent” or “economicprofit”: taxing pure rent is efficient because it does not distort economicbehaviour. Taxing gains that arise because of imperfect competitionis also often efficient. Finally, gains in operating businesses andspeculative gains on financial markets may represent a mixture of rent,return to risk-taking and return to managerial skills. Although taxingthe latter two types of return may distort economic behaviour, themagnitude of the distortions may be limited — for instance, where themanagerial skills are relatively location-specific, for example, involvingspecific language, culture and/or political skills.Capital gains that arise in the ways just described can be contrastedwith some other forms of gains. One kind of nominal capitalgain results from inflation: in an inflationary context, even depreciatingequipment can sell for a greater nominal amount of cash than thepurchase price. Another kind of gain is income that has already beenearned on the asset but that has been added to or reinvested in (capitalizedinto) the original asset. For example, if a corporation has retainedearnings and does not distribute such earnings to shareholders, the priceof its shares will go up simply because the shareholders have deferred therealization of their income, not because the corporation’s business hasbetter prospects than before. 11 If a shareholder sells his or her shares, thegain realized may simply be the income that he or she could have realizedas dividend if the corporation had made a distribution.In general, the design of an income tax may need to providespecial treatment for these latter forms of nominal capital gain. In thecase of inflation, its presence should ideally be taken into account indetermining whether the taxpayer has any taxable gain. In the caseof accrued earnings realized through a sale of the asset, it may be11Similarly, if a zero-coupon bond with a $100 face amount is issued fortwo years in an environment where the market interest rate is stable at 5 percent, no one will buy the bond initially if it is issued for more than $90.703.After a year (with the bondholder being one year closer to maturity) the bondwill be worth $95.24, but the increase from $90.703 merely represents anaccrual of interest, and not a change in the expectation of the bond’s yield.113