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Squawk Box Special Edition – Fair Taxation of Stock Options in Canada

Squawk Box took a remarkable new direction this afternoon, with a special edition focused on the issue of fair taxation of stock options in Canada. The heart of the issue is simply this: in Canada the gain on a stock option is taxed as employment income, not capital gain, which means that any losses from that stock should you choose to exercise and hold the stock, cannot be written off against the gain. In practical terms, this has led to a litany of hardship for ordinary Canadians.

Our guest Ragui Kamel explained the issue, and then how it is affecting many ordinary people who are being forced to mortgage or sell homes, and liquidate RRSPs in order to pay tax on income they never received. Ragui and his group have met with MPs, ordinary people affected by the situation, business leaders and more.

Once you’ve listened to this podcast, then please visit:

CFET – the site of the organization Canadians for Fair and Equitable Taxation. Read the impact statements, check out the slide presentation, and sign the petition.

The CFET Facebook Group – join the group, and contribute to the discussion.

And stay tuned. We’ll do another call to talk about the progress on this issue in the future.

{ 9 comments… add one }

  • ragui April 6, 2008, 12:34 pm

    I think Gary Will does not understand the issue.

    CFET is not arguing a preferential treatment of employment benefit. It is arguing that the employment benefit on stock options should not have been calculated the way it was, namely (1) assessed at exercise time vs stock sale time and (2) assessed on the paper value at exercise vs the real value at stock sale. By calculating it that way, CRA is in fact taxing people on "phantom income": money they never really received

    Canada is the only industrialized country which taxes options at exercise (ie buying something) vs when the stock is sold … and the only country which taxes on the paper value at exercise vs the real value realized when the stock is sold.

    For example, the US taxes at the time of sale not at the time of option exercise. The determination of the tax, as per the1981 stock option law, is “If the sales price of the shares is less than the Fair Market Value on the date of exercise, the amount of ordinary income is limited to the amount of gain, if any.” This is fair and does not tax people on “phantom income”

    CFET is open to any solution that fixes the problem including recalculating the benefit on real value realized as is done in the US and other countries. The suggestion of using the capital loss on the shares to offset the employment income on those same shares also seems an elegant and fair solution to the problem.

  • Gary Will April 6, 2008, 1:21 pm

    CFET makes a poor case. While it pretends not to be lobbying for preferential tax treatment, in fact that’s exactly what it’s arguing for. I’m all for relieving tax burdens, but there’s no fairness in what CFET is lobbying for.

    Under the changes it wants, some people would get a special tax rate on their employment benefits while others receiving the same benefit wouldn’t — based only on how they subsequently decided to invest the gains from that benefit. CFET wants some people to be able to use capital gains losses to offset income but not others (why should people who paid for their shares through an employment benefit be able to do this and no one else?)

    Maybe in the few cases where people were legally barred from selling their shares (as opposed to contractually agreeing not to sell), there might be an argument to be made — assuming there isn’t already an exception in the current law — but otherwise, there’s no “fairness” here.

  • Larry April 6, 2008, 7:36 pm

    “Under the changes it wants, some people would get a special tax rate on their employment benefits while others receiving the same benefit wouldn’t …”

    Gary, the solution proposed by CFET will prevent exactly what you have stated.

    In fact, the existing flawed ESO legislation has caused exactly what you have mentioned above. By not fixing the flawed ESO legislation, the govt is forcing some unfortunate taxpayers to pay an unfair and excessive amount of tax, while others don’t have to.

    Any reasonable and fair minded canadians would understand that there is no way to settle a REAL tax liability with an IMAGINARY income.

  • cagey April 6, 2008, 8:18 pm

    Gary should get his facts straight b4 he pipes off. It is apparent his is an ignorant and ill informed opinion.There is nothing preferential about what is being asked and if I understand it correctly cfet could have taken several more self serving tacts than what their mission/mandate and efforts clearly prove.

  • Ken April 6, 2008, 9:41 pm

    Gary Will:-
    You obviously do not fully understand the situation. The CFET objective is not that some people will have a loophole to avoid real taxes on real income.

    ragui is telling it the way it is. There are many ordinary Canadians burdened with on-going deferred taxes levied on theoretical but purely imaginary income.

    If it were a trade off I would prefer some people get away avoiding taxes than anyone finacially ruined by unjustified taxes.

    But that is not the case here. CFET’s objective is “Fair and Equalized Taxation for All Canadians.

    No one should have a problem with that.

  • Gary Will April 7, 2008, 3:17 pm

    It's preferential tax treatment, and apparently no one who supports these reforms can be bothered to put it to the test.

    Three employees all work at Acme Corp., all granted the same number of stock options, same strike price, etc. They all exercise their options on the same day. They've all received the exact same employment benefit. Alan chooses to keep the Acme shares he bought with his benefit. Bob chooses to transfer his money to a mutual fund and Carla transfers her money to shares in Widget Inc. One more person to add: Don. He doesn't work for Acme, but buys shares in the company at the same time the others exercise their options.

    Acme stock tanks. So do shares in Widget. The mutual fund does okay. Alan, Bob, and Carla all received the exact same employment benefit, but CFET thinks Alan — but only Alan — should have his tax burden decreased. Carla's financial loss is just as severe, but CFET isn't concerned about her. Why not? Apparently because when she had her broker switch her shares from Acme to Widget, there was at least theoretically a middle step where her money was in cash, if even only for a couple of seconds. Don also suffered the same loss but CFET doesn't care about him at all. Why not? Because he didn't pay for his shares through an employment benefit at Acme. He paid for them through money earned at a different company, so he's out of luck.

    Three people receive the same employment benefit, but only one would have their tax burden decreased by CFET. Three people are wiped out financially, but only one would have their tax burden decreased by CFET (and it's the same guy in both cases, of course).

    But it's not preferential treatment! Let's get that straight right now!

    All CFET can do is insist that Alan, Bob, and Carla didn't really receive the same employment benefit — even though they received the exact same option grant and all exercised their options at the same time. CFET needs to argue that the value of the employment benefit should be measured differently for tax purposes if — and only if — the recipient chooses to keep the gains from that benefit in shares of their employer. No one else would be entitled to the same relief.

    Any reform to the tax law needs to be fair to Alan, Bob, Carla, and Don and not just single out Alan as the only one we should be concerned with. When you come up with something fair to all four, then I'll be interested. What you're proposing now isn't.

    Maybe we should be thankful that CRA doesn't tax options when they're awarded. They could use Black-Scholes to assign a value to the options as a benefit and tax that before they're ever exercised. Now that would be something to get upset about.

  • Larry April 7, 2008, 4:03 pm

    Gary, you said: "They’ve all received the exact same employment benefit."

    Therein lies the problem to your "tests".

    When employees exercise their option to buy shares, they have received NO tangible benefit of any form. This assumption is the root of the whole problem.

    The tax treatment of Options and Rights (of various kinds) have undergone a long history of evolution since they were introduced back in the 1950's. In the US, the current legislation as amended in 1981 treat the Granting and Exercising of options as non taxable events.

    As for your "tests", you will find that if the tax were imposed on the actual proceed from the actual disposition of the shares acquired from the exercise of the option, then every one of the characters will be treated fairly.

  • ragui April 7, 2008, 4:45 pm

    Gary, you continue to misunderstand the CFET position.

    As I said, CFET believes that the benefit should be assessed at stock sale time and on the value of the stock at that time (as is done in every other industrialized country).

    In your example, while everyone exercised at the same time, Bob and Carla sold their shares and therefore realized the money. They received cold, hard cash which they chose to invest as they will.

    Alan did not sell his shares and therefor realized no money and never received anything. Taxing him is to tax him on a phantom income

    Assessing at option exercise time makes no sense as you have purchased something whose eventual value is undeternined (the only place in the tax code where you get assessed a tax on a purchase vs a sale) … The right and fair thing to do is to tax at sale time.

    and I will repeat: Canada is the only industrialized country that seems silly enough to tax at exercise

  • Ken April 7, 2008, 8:59 pm

    Gary Will:-
    CFET is not promoting the protection of all market speculators from Capital Loss. Once your example players traded, exchanged or sold their grant shares they were then just ordinary speculators.

    What we are promoting is the fair and equitable taxation of those who held their shares past the exercise date — were taxed on an unrealized inflated FMV and then left to stew in their own juice with the subsequent loss on those same shares.

    Ken

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