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The Companion Advisor:
Taxes & EstatesTaking Stock Option grants count as income
Employees who participate in employee stock purchase plans (ESPPs) or exercise employee stock options only to find the price of the shares plummet thereafter are left with a potentially explosive tax problem. That's because, under Canadian tax law, if you purchase shares through either an ESPP or by exercising an employee stock option, your taxable employment benefit (and thus your tax liability) is based on the difference between the price you paid for the shares and the fair market value of shares on the date you receive them. While the value of the taxable benefit is fixed when the shares are acquired, the benefit can generally be deferred until the year you sell the shares. Therein lies the problem: suppose the shares have subsequently declined in value between the date you received them and the time you ultimately sell them. The resulting loss is considered to be a "capital loss" which can only be used to offset capital gains and cannot be deducted against the taxable employment benefit that arose upon acquiring the shares. It is this mismatch of capital loss against employment income that has created the harsh economic reality for employees who face massive tax bills on money they never "received." While a remission order was granted late last year forgiving both the income taxes and arrears interest of 35 ex-employees of SDL Optics Inc. that arose from participation in their employer's stock purchase plan, whose shares subsequently plummeted, that order only applies to them. What about the estimated tens of thousands of other Canadians in these situations? A tax case decided in late February (Howard v. The Queen, 2008 TCC 515) may offer a glimmer of hope. David Howard, a chartered accountant, was employed as a vice-president and chief financial officer with Cell-Loc Inc. from May 1999 to December 2000, through both the height and subsequent meltdown of the technology bubble. Howard received stock options as part of his remuneration. He was unable to sell the shares because of a trading blackout as an insider. He was also encouraged to hang on to his share position "in order to communicate confidence to the marketplace." On December 13, 2000, Howard lost his job. He immediately sold all his Cell-Loc shares, and subsequently reported a capital loss of about $800,000 on his 2000 tax return in respect of the disposition of those shares. In late February of 2000, Howard received his T4 from Cell-Loc, showing a large stock benefit Howard needed to claim on his return. After being assessed for the tax owing on the exercise of stock options, Howard sought professional tax advice and hired KPMG to re-file his 2000 return to report his Cell-Loc stock losses as an "income loss" rather than a capital loss. Not surprisingly, the CRA refused to re-characterize the loss as an income loss. In court, Howard took the position that he was a "trader or dealer" in the business of selling Cell-Loc shares and thus his loss should be considered a fully tax-deductible business loss as opposed to a capital loss, which would not have been otherwise deductible against his stock option employment taxable benefit. As discussed in a prior column (Accounting for Gains), the issue of "income vs. capital" comes up regularly; the court generally looks to a number of factors in determining the appropriate tax treatment. These factors include: the frequency of transactions, the length of the holdings, the intention to acquire for resale at a profit, the nature and quantity of the securities held and the time spent on the activity. The judge weighed the above factors and concluded that the evidence "was
consistent with [Howard's]... stated intention of acquiring the shares to resell
for profit at the earliest best opportunity." Howard's share activities
in 2000 thus amounted to those of a "trader or dealer" in the business
of selling his Cell-Loc shares" and thus Howard was allowed to claim the
loss as a business loss on his 2000 return. Notice:
Fiscal Agents Financial Services Group are not engaged in rendering tax,
accounting or legal professional services or advice. The comments in this
article are not intended, nor should they be relied upon, to replace specific
professional advice. Before acting on material contained herein. Readers
should seek advice that is appropriate to their personal circumstances
from a professional advisor.
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, Fiscal Agents Money Management Newsletter
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