GETTING PERSONAL CANADA: Stock Options Get Complicated

Hemant Tilak

Mar 15, 2010

By Monica Gutschi (Dow Jones Newswires),  The Wall Street Journal

 

Stock options may no longer be as attractive a compensation.

Changes to tax rules governing stock options unveiled in the 2010 budget were mainly intended to remove a huge tax burden from a group of IT executives blindsided by the 2001 technology crash. But they've also had a pesky side effect: employees who cash in their stock options will now get an immediate tax hit, while employers will no longer get a tax deduction when they do.

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In the past, employees were allowed to defer the tax they owed on the difference between what they paid for the shares and the trading price on the day they exercised their options. The tax didn't have to be paid until they actually sold the shares. Moreover, although the options were considered employment income, they were taxed at 50% as if they were a capital gain.

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The 2010 budget included tax relief for this group, and proposed changes intended to avoid future mismatches.

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Hemant Tilak, a compensation expert at Osler, Hoskin & Harcourt LLP says "The government's hope is that people won't find themselves in this position in the future, It was a very bizarre situation that people found themselves in."

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Under the new rules, employees can no longer defer the tax when they exercise their stock options, and employers must withhold the tax. Additionally, the new tax rules eliminate the double deduction that was available when employees took their stock options in cash rather than in shares. The cash payout meant employers could claim a deduction for compensation expense while the employee still enjoyed the 50% capital gains deduction. Now, it's one or the other.

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Tilak believes, the employee and employer will "reach an accommodation" on the issue, or companies could prohibit cash payouts in the future.

Still, he says the changes could "make employers pause a little bit" before issuing stock options and also run counter to governance trends that encourage a greater alignment between employees and their companies through the use of stock-based compensation. Moreover, he notes, companies have few alternatives for mid-term incentives, as restricted stock units have a maximum term of three years, and deferred share units are intended to be paid at the end of a career.

"I think most employers may take a look at option cash payouts, and we may see them curtailing them a little bit," Tilak says.