At Strata-G, we believe that effective communication is the cornerstone for building Trust and Confidence with those we serve. Therefore, we will not throw terminology, or Income Tax References at you in conversation without walking you through the full context of what we are trying to communicate, as information is knowledge. Without context, “a 128.1(4) exposure” may be as confusing to you , as the purpose of an electromechanical shaker is to us. With context, we learn!
Our “Deciphering the Act” Series walks through various situations to ascertain what the Income Tax Act is most likely trying to communicate, knowing full well we cannot lump every situation into one scenario. The smallest detail may take us down another path, to arrive at a completely different result. As always, you know where to find us if we can help tailor a solution directly to your business.
We are a start-up Canadian Controlled Private Corporation (CCPC), positioned well within a network that attracts talented Engineers from within Canada and from outside. To encourage retention of this high-end talent we offer stock options as part of our compensation package. People may still choose to move on, and for those that choose to leave to return to a Country outside of Canada, what are some of the key tax provisions we should be aware of?
The purpose of this article is to address the tax implications for the individual holding the stock option rights who is Emigrating from Canada, and for the employer who will need to withhold tax on the compensation at the appropriate time. The article takes a relatively straight forward path through the Act. To illustrate how facts can alter the trajectory of end tax result, if the Corporation granting the stock based compensation is not a CCPC, the tax event for both the individual and the corporation’s withholding tax requirements will incur much sooner than for a CCPC (we will provide a slightly revised outcome below for non-CCPC). We encourage you to discuss your facts with a Tax Advisor to ensure the appropriate conclusion is drawn.
As tax legislation is as dull to type, as it is to read, I will not spend too much time in the wording of the Act, however, as you will see how we bounce from provision to provision, it is important that when reading sections of the Act you read the full text and notes. As it is easy to believe you are on the cusp of the answer you were seeking, only to find that one, or eight, more door(s) have opened. Or the doors you used to walk through, have been bricked closed.
What are Stock Options?
Let’s begin our stock compensation journey with an explanation of what stock options are. In general, by providing a stock based incentive to your employee you are offering a future right to exercise (acquire) stock at presumably a lower price than the current market value (known as in-the-money), when the stock has appreciated in value at a future date. The benefit of which is that the employee can then choose to sell the stock for a gain or continue to hold the stock hoping that the value of the stock continues to appreciate. If the value suddenly tanks, the employee can walk away from the options without the risk associated with purchasing shares that have tanked on the open market.
Is a lengthy read, the premise of which is that employee stock option benefits are generally included in income in the year of the exercise or disposition of the option. This is the income trigger for non-CCPC shares, at the time the shares are exercised. Let’s read on…
However, in the case of options granted by a CCPC, the benefit is deferred to the year in which the securities are disposed of. If the value of the company begins to soar, an employee may wish to exercise to lock in a profit element. If they choose to hold the shares to dispose in a future period, the taxation of their locked in profit is deferred to that later date. A key difference to options granted by non-CCPC’s. Let’s read on…
We will now add to our example:
If not a CCPC, upon exercising the options the employee will realize a taxable benefit for that taxation year, and the corporation has a withholding requirement, due to the CRA by the 15th of the month following the realization of the benefit – this can trip up many Corporations, as the exercising of Stock Options is not always on the payroll radar.
When income is ultimately included in income (Exercise date for Non-CCPC, and Final Disposition for CCPC employees), paragraph 110(1)(d.1) provides parameters for an employee to receive a ½ deduction on their CCPC stock options. Effectively, treating the income as a capital gain, for which only 50% is taxable.
Well this hasn’t been too bad, Non-CCPC will be taxed in the year the options are exercised, and for the former CCPC employee leaving Canada, will realize an income pick-up for tax when they dispose of their shares. Both employees may be entitled to a 50% deduction (please reach out to discuss situations where 50% deduction may not be available). I think we are good…
remember to check for whether there may be other doors to open.
Known as the Departure Tax on Emigration provision, 128.1(4) creates a deemed disposition of certain capital property, when emigrating from Canada. Equal to the fair market value of the property at the time the individual becomes a non-resident of Canada.
Well, that turned south in a hurry. Perhaps there is one last door to open
For the purposes of this section (stock options) and paragraph 110(1)(d.1) (1/2 deduction), a taxpayer is deemed NOT to have disposed of a share acquired under circumstances to which subsection (1.1) (CCPC tax deferral) applied solely because of subsection 128.1(4) (Departure tax on emigration). Well that was a mouthful!
The departure tax that is triggered on the potential for accrued capital gains for certain capital property upon emigration should not include stock options arising from CCPCs. What a Relief!!
Please remember that once the shares are ultimately sold, there should be a taxable event in Canada for the non-resident to report and pay tax, which means withholding tax obligations to the employer, as the stock options were granted as a result of employment in Canada. In addition, there may be potential for double taxation in the Country of residency, depending on foreign tax credit rules in that Country.