Witholding and remittance requirements new for 2011
Draft legislation was recently released by the Department of Finance to implement amendments to the tax treatment of stock options announced in the 2010 Federal Budget. These proposed changes impact a number of aspects of the taxation of stock options and many stock options plans may require amendment as a result.
Under the Income Tax Act, where an employee exercises a stock option a taxable benefit is generally deemed to be received by the employee in the taxation year in which the option is exercised. This benefit is equal to the difference between the fair market value of the shares on the date of acquisition and the exercise price paid by the employee (plus any amount paid for the right to acquire the option.) If certain conditions are met, the employee may be eligible to claim a deduction.
Cashing out stock options
A practice had developed whereby employers designed their stock option plans to permit an employee to dispose of, or cash out, their options in return for a cash payment from the employer equal to the in the money amount of the option. The cash out could take the form of companion or tandem stock appreciation rights.
This practice permitted both the employer and the employee to obtain favourable tax treatment, as the employee maintained the entitlement to the stock option deduction, while the employer became entitled to a tax deduction in respect of the cash payment to the employee.
The draft legislation would prohibit this double benefit by disentitling the employee to the stock option deduction unless the employee acquires the shares under the option or, if the employee cashes out the option, the employer files an election not to claim a deduction in respect of the cash payment to the employee.
Where an employer chooses to forego this deduction, the following steps are necessary:
•the employer must file an election with the Canada Revenue Agency (CRA) to forego the deduction
•the employer must provide the employee with written evidence of this election
•the employee must include this written evidence with the income tax return in the year in which the deduction is claimed.
In light of this change, employers should consider whether they wish to continue to offer option holders the ability to cash out and to ensure the terms of the stock option plan reflect this choice. Employers should also notify option holders of the changes to the rules and the risks involved in cashing-out their options.
Witholding and remittance obligations
Employers that pay remuneration are required to withhold at source a prescribed amount and remit the withheld amount to the CRA on account of the employee’s income tax liability for the year. Stock options are a form of remuneration, thus a benefit arising from the exercise or cash out of a stock option is subject to this withholding requirement.
In the past, the CRA administratively waived the withholding requirement in circumstances giving rise to undue hardship, permitting the employee to pay the associated tax on filing a tax return for the year. With the draft legislation changes, the employer becomes the gatekeeper and must ensure the withholding requirement is met.
The legislation would eliminate the undue hardship exception and require withholding at source on all stock option benefits realized as of Jan. 1, 2011, other than:
•benefits in respect of the exercise of an option to acquire a share of a Canadian-controlled private corporation
•certain amounts deductible by the employee in respect of the donation of a share to a registered charity
•benefits arising under a stock option agreement entered into before 4 p.m. on March 4, 2010, and which included a requirement for the employee to retain the shares so acquired for period of time
•the portion of the stock option benefit eligible for the stock option deduction.
The withholding requirement is intended to address the situation in which the employee is unable to pay the associated tax due to a decline in the value of the shares between the date of exercise of the option and the filing of the employee’s tax return for the year. The withholding for the stock option benefit is to be computed as if the stock option benefit was a bonus.
This will require the employer to determine the amount that ought to have been withheld on the employee’s remuneration for each pay period in the year, including the pay periods prior to the receipt of the stock option benefit, as a result of the increase in annual remuneration resulting from the benefit.
The employer will then be required to withhold an amount to account for the benefit and its impact on the employee’s increased annual remuneration, and to remit this sum to the CRA on or before the remittance due date for the pay period in which the stock option benefit arises.
The withholding requirement could lead to onerous results, particularly where the amount of the stock option benefit is significant. Employers and employees may have to reconsider the timing of the exercise of options. Employers will want to ensure stock option plans provide for great flexibility in the methods of funding the withholding requirement, including extra withholding on cash remuneration or cash payments from employees on the exercise of an option.
Changes to the taxation of stock options will impact the design of stock option plans as well as the administration of such plans. Employers need to consider whether to retain features such as cash out rights, how they will administer the withholding requirement, whether the stock option plan provides sufficient flexibility and whether or not the plan should be replaced by other forms of stock-based compensation.
Paul Carenza and Miriam Al-Shikarchy are lawyers with Lang Michner LLP in Toronto. Contact Carenza at (416) 307-4125 or at [email protected]. Contact Al-Shikarchy at (416) 307-4249 or at [email protected].
Under the Income Tax Act, where an employee exercises a stock option a taxable benefit is generally deemed to be received by the employee in the taxation year in which the option is exercised. This benefit is equal to the difference between the fair market value of the shares on the date of acquisition and the exercise price paid by the employee (plus any amount paid for the right to acquire the option.) If certain conditions are met, the employee may be eligible to claim a deduction.
Cashing out stock options
A practice had developed whereby employers designed their stock option plans to permit an employee to dispose of, or cash out, their options in return for a cash payment from the employer equal to the in the money amount of the option. The cash out could take the form of companion or tandem stock appreciation rights.
This practice permitted both the employer and the employee to obtain favourable tax treatment, as the employee maintained the entitlement to the stock option deduction, while the employer became entitled to a tax deduction in respect of the cash payment to the employee.
The draft legislation would prohibit this double benefit by disentitling the employee to the stock option deduction unless the employee acquires the shares under the option or, if the employee cashes out the option, the employer files an election not to claim a deduction in respect of the cash payment to the employee.
Where an employer chooses to forego this deduction, the following steps are necessary:
•the employer must file an election with the Canada Revenue Agency (CRA) to forego the deduction
•the employer must provide the employee with written evidence of this election
•the employee must include this written evidence with the income tax return in the year in which the deduction is claimed.
In light of this change, employers should consider whether they wish to continue to offer option holders the ability to cash out and to ensure the terms of the stock option plan reflect this choice. Employers should also notify option holders of the changes to the rules and the risks involved in cashing-out their options.
Witholding and remittance obligations
Employers that pay remuneration are required to withhold at source a prescribed amount and remit the withheld amount to the CRA on account of the employee’s income tax liability for the year. Stock options are a form of remuneration, thus a benefit arising from the exercise or cash out of a stock option is subject to this withholding requirement.
In the past, the CRA administratively waived the withholding requirement in circumstances giving rise to undue hardship, permitting the employee to pay the associated tax on filing a tax return for the year. With the draft legislation changes, the employer becomes the gatekeeper and must ensure the withholding requirement is met.
The legislation would eliminate the undue hardship exception and require withholding at source on all stock option benefits realized as of Jan. 1, 2011, other than:
•benefits in respect of the exercise of an option to acquire a share of a Canadian-controlled private corporation
•certain amounts deductible by the employee in respect of the donation of a share to a registered charity
•benefits arising under a stock option agreement entered into before 4 p.m. on March 4, 2010, and which included a requirement for the employee to retain the shares so acquired for period of time
•the portion of the stock option benefit eligible for the stock option deduction.
The withholding requirement is intended to address the situation in which the employee is unable to pay the associated tax due to a decline in the value of the shares between the date of exercise of the option and the filing of the employee’s tax return for the year. The withholding for the stock option benefit is to be computed as if the stock option benefit was a bonus.
This will require the employer to determine the amount that ought to have been withheld on the employee’s remuneration for each pay period in the year, including the pay periods prior to the receipt of the stock option benefit, as a result of the increase in annual remuneration resulting from the benefit.
The employer will then be required to withhold an amount to account for the benefit and its impact on the employee’s increased annual remuneration, and to remit this sum to the CRA on or before the remittance due date for the pay period in which the stock option benefit arises.
The withholding requirement could lead to onerous results, particularly where the amount of the stock option benefit is significant. Employers and employees may have to reconsider the timing of the exercise of options. Employers will want to ensure stock option plans provide for great flexibility in the methods of funding the withholding requirement, including extra withholding on cash remuneration or cash payments from employees on the exercise of an option.
Changes to the taxation of stock options will impact the design of stock option plans as well as the administration of such plans. Employers need to consider whether to retain features such as cash out rights, how they will administer the withholding requirement, whether the stock option plan provides sufficient flexibility and whether or not the plan should be replaced by other forms of stock-based compensation.
Paul Carenza and Miriam Al-Shikarchy are lawyers with Lang Michner LLP in Toronto. Contact Carenza at (416) 307-4125 or at [email protected]. Contact Al-Shikarchy at (416) 307-4249 or at [email protected].
