Taxation Changes to Stock Options Hurting Not Helping

In its 2010 Budget, the Government of Canada announced changes to the taxation of stock option compensation. While one change benefits workers with equity worth less than the tax liability deferred from exercising their options, other changes make stock option compensation worse for everyone. The changes are particularly troublesome for small and medium-sized enterprises (SMEs).

The government has opted to fix problems with Canada’s stock option compensation with additional rules and administration, rather than tackling the two fundamental underlying issues:

• Taxation of Virtual Gains Instead of Real Gains – by taxing employees when stocks options are exercised, the government taxes virtual gains not actual gains without allowing those gains to be offset with corresponding losses.
• Overly Complex Administration –special rules for each class of company in Canada (CCPC, non-CCPC, public) make tax rules exceedingly complex for companies to understand, and even worse to communicate to employees

Stock options are an important compensation tool, particularly for SMEs in knowledge-based sectors. These SMEs need to preserve cash for innovation and growth. By providing equity compensation, options allow SME’s to attract top managerial and technical talent they otherwise couldn’t afford without sacrificing cash. To foster the growth of the innovation economy and deliver increased productivity for the country, Canada needs to sharpen its compensation tools instead of blunting them as it has with these changes.

2010 Budget Changes

Specifically, the 2010 Budget changes include the following:

1. Removal of the ‘Double Dip’ tax benefit

by removing a provision of which many companies take advantage, the government effectively wants to increase the rate of taxation on stock option compensation.

2. Limitation of Tax Liability

in recognition that the current rules on stock option compensation tax virtual gains without allowing for offsetting losses, the government intends to limit employee’s tax liability to the value of their equity at the time of sale.

3 . Addition of Withholding Requirements

except for private Canadian owned companies (CCPC), the government will eliminate the tax deferral option and place the administrative and financial burden of employees’ tax liability onto employers through a new holdback on exercised shares with no indication where the cash necessary to satisfy the withholding requirement is supposed to come from.

Issues with Compliance

For companies trying to be compliant, the new changes only serve to create even more ambiguity and confusion. Worse, the government has provided little communication to clarify the situation.

Technology companies have raised a number of concerns, particularly surrounding events that change a company’s status. Events such as large investments by foreign investors, and IPOs are typically considered to be success milestones in the life cycle of technology companies. The budget changes make these events even more confusing and difficult to manage. At least one local technology company has already shelved their IPO due to tax liability concerns.

Our Position

The BCTIA would like to see a wholesale review of the way that stock option compensation is taxed in Canada, but such a review takes time. In the interim we are asking the government to abandon the changes they have proposed in the 2010 Budget. While the system was imperfect prior to the 2010 Budget changes, it’s one that companies at least understand how to navigate. It’s a regime under which we can continue until the government makes the wholesale changes required for Canada to be a leader in attracting and retaining talent.

Canada is currently in a strong fiscal position relative to other countries. We can afford to revisit the structural issues surrounding stock option compensation and improve our global competitiveness by helping Canadian companies (in all sectors) attract and retain talent.

Rather than creating disincentives, our government needs to encourage more Canadians to invest in the companies they work for and own. Canada needs more companies that are strong enough to take on the world and generate export wealth.We have to have a system that rewards Canadians for working hard, for being entrepreneurs, and for taking risks.

Next Steps

To encourage the Federal Government to reconsider their changes, the BCTIA will be rallying the industry over the next few weeks and working with our counterparts across the country to do the same.

We’ll be meeting with MPs and Ministers to explain the issues with these changes and encourage them to adopt the rollback in the short term and revisit the systemic issues surrounding stock option compensation in the medium term.

Seek Assistance
If your company provides equity-based compensation, consult your tax professionals to ensure your company is adequately prepared for the proposed changes should those be actually be legislated in.

Also, please watch for additional communication from the BCTIA and others on the changes and how they might impact your organization.

Provide Your Voice
For your part, please take a moment to Click Here and Provide Your Voice. It is extremely important that we have your voice to provide real evidence for government on the importance of stock compensation to our industry and the effect of these changes on us.