Archive for May, 2012

Tax Treatment of Restricted Stock Unit (RSU) Benefits

May 21, 2012

30 comments

If you work for a large company, chances are Employee Stock Option benefits (ESOPs) have been replaced with Restricted Stock Units (RSUs). There are significant differences between tax treatment of ESOPs and RSUs. In this post, we will look at how RSUs are taxed for Canadian residents. Restricted Stock Units are simply a promise to issue stock at some future vesting date(s) provided some condition(s) (often just being an employee of the company on the vesting date) are met. It is important here to distinguish RSUs from Restricted Stock Awards (RSAs). RSAs are stock grants in which employees may not sell or transfer the shares until they vest but are entitled to dividend payments. RSAs are unpopular in Canada due to their tax treatment: the FMV of the the RSA grant is taxed as employment income at grant but employees will receive the cash from the sale after the grants vest, which may be many years later.

Like stock options, there are no tax implications when RSUs are granted to an employee. At the time of vesting, the FMV of the RSU grants that vested is considered as employment income. Starting in 2011, the Canada Revenue Agency requires employers to withhold taxes on employee stock benefits, including RSUs. Therefore, your employer will likely sell a portion of vested restricted stock and remit it to the CRA. The FMV of restricted stock and taxes withheld will be added to the Employment Income (Line 101) and Income Tax Deducted (Line 437) of the T4 slip for the financial year.

The employee has to keep track of restricted stock FMV at the time of vesting. If there are multiple vesting events, the adjusted cost base of the stock must be calculated. When the stocks are eventually sold, the difference between the proceeds of the sale and the adjusted cost base of the shares should be reported in Schedule 3 Capital Gains (or Losses).

Let’s take an example. Sue works for ABC Corp. and was awarded 300 RSUs on May 1, 2011. ⅙th of the award will vest every 6 months provided Sue is employed on the vesting date. Sue’s first batch of 50 units of restricted stock vested on November 1, 2011. ABC was trading at $10 and Sue’s employer sold 23 shares and remitted the withholding tax to CRA. Sue’s second batch of 50 units of restricted stock vested on May 1, 2012. ABC was trading at $12 and Sue’s employer again sold 23 shares and remitted the withholding tax to CRA. In both cases, her employer included $500 and $600 in employment income and $230 and $276 in income tax deducted in Sue’s T4 for 2011 and 2012 respectively. Note that, unlike stock options which are eligible for the stock option deduction and hence are taxed at 50 percent, there is no favourable tax treatment accorded to RSUs.

On May 15, 2012, ABC hit $15 and Sue sold the 54 shares of ABC Corp. that she holds. Sue’s adjusted cost base is $11 (27 shares acquired at $10 and 27 shares acquired at $12). Since she sold for $15, her capital gains are $216, which she would declare when filing her 2012 tax return in Schedule 3.

Sector Breakdown of Diversified Portfolios

May 15, 2012

13 comments

In a recent column, The Globe & Mail’s Rob Carrick (see Beware the limitations of buying the index, May 11, 2012) pointed out that investing in just the TSX Composite index might leave an investor with an unbalanced portfolio because of the index’s concentration in just three sectors: financials, energy and materials. The criticism is a valid one because, as you can see from the chart below, resource companies make up more than half the index and financials make up another one-third of the index. (As an aside, the sector breakdown of the S&P/TSX 60 index, which is tracked by the iShares S&P/TSX 60 ETF – TSX: XIU is pretty much the same as the broader Composite index).

Sector Breakdown of the S&P/TSX Composite Index

This limitation of the TSX Composite Index is one reason why passive investors diversify their portfolios globally. The US Total Stock Market, for instance, offers much better diversification. The three dominant sectors in the Canadian market make up less than a third of the US stock market. The US stock market also offers exposure to sectors such as Information Technology, Healthcare and Consumer goods that have a much smaller representation in the Canadian index.

Sector Breakdown of US Total Stock Market

The MSCI EAFE Index which provides exposure to developed stock markets in Europe and the Pacific region is also well diversified across sectors. Financials and resources make up just 40 percent and the index has significant allocation to stocks representing Consumer goods, Utilities and Telecommunication services.

Sector Breakdown of MSCI EAFE Index

A globally diversified index portfolio such as the Sleepy Portfolio, which is split between Canadian, US, EAFE and Emerging Markets has a much better balance between sectors when compared to the Canadian stock market. The allocation to financials and resources drops to less than half the portfolio compared to three-quarters for the Canadian-market only index investor. And the allocation to sectors such as Consumer goods, Information Technology and Healthcare is also boosted substantially.

Sector Breakdown of the Sleepy Portfolio

What is iShares Planning After Acquiring Claymore

May 2, 2012

6 comments

Recently, I had a chance to chat with Mary Anne Wiley, head of BlackRock Canada on what the 800 pound Gorilla in the ETF marketplace plans to do after the blockbuster acquisition of the #2 player Claymore Investments was recently finalized. After the acquisition closed, iShares rebranded all Claymore products (ticker symbols remained the same) but apart from that the only changes have been some minor adjustments. Here’s what I learnt:

  • I started off by asking why the Claymore Inverse 10 Year Government Bond ETF (CIB) was terminated and whether it presages any more fund closures. Ms. Wiley said that the decision was made because CIB was not consistent with the iShares brand since it was most effective for short-term holding periods and also had no strong market appeal.
  • iShares plans on maintaining the lineup of Research Affiliates Fundamental Index (RAFI) ETFs and laddered fixed-income ETFs both of which are very popular among individual investors. It appears that laddered ETFs make it easier to introduce the concept of low-cost fixed-income investing to retail investors compared to capitalization-weighted products, which are more popular among institutional investors.
  • Dividend Reinvestment Plans (DRIPs), Share Purchase Plans (SPPs) and Pre-Authorized Contribution Plans (PACCs) will be maintained for the Claymore ETFs.
  • DRIPs will be rolled out to all iShares products later this year. Since, many discount brokers already offer synthetic DRIPs on most ETFs, many investors already have the ability to reinvest dividends.
  • The advisor class ETFs which are sold through advisors and have an extra fee tacked on top to compensate for financial advice will be maintained for existing products.
  • iShares plans to roll out advisor class ETFs to the other products in its lineup.