The tax on Employee Stock Purchase Plans (ESPP) has two components: the difference between the offering price and the fair market value (FMV) of the stock is treated as employment income and the difference between the FMV and the selling price is treated as capital gains or losses.
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.
As I am preparing my income taxes, I am reminded yet again of the trap that the Canada Revenue Agency has set for taxpayers in the T1 General form with this innocuous question:
“Did you own or hold foreign property at any time in 2011 with a total cost of more than CAN$100,000? (See “Foreign Income” in help for details)”
An unsuspecting taxpayer might reasonably infer “foreign property” to mean a condominium in Florida or a not-so-secret-these-days Swiss bank account and owning nothing of the kind might answer “No” to the question. The General Income Tax and Benefit Guide put out by the CRA does not shed much light on the question either.
To find out the details of what constitutes “specified foreign property” in CRA’s eyes, one has to turn to the information provided in Form T1135 Foreign Income Verification Statement. In it, CRA defines “shares of non-resident corporations held by the resident filer or on deposit with a Canadian or foreign broker” and “interests in mutual funds that are organized in a foreign jurisdiction” as specified foreign property. In other words, if our taxpayer held US stocks or ETFs with a cost of more than $100,000 in a Canadian investment brokerage account, she must answer “Yes” to the question in T1 General and file Form T1135.
Curiously, a Canadian taxpayer owning what one would reasonably consider “foreign property”, say a condo in Miami purchased for $250,000, strictly for personal use, does not have to file T1135! The taxpayer, who simply assumed that foreign stocks held in taxable Canadian brokerage accounts for which trading summaries are filed annually with the CRA and income taxes are paid, has to file T1135 if the cost of foreign stock holdings exceeds $100,000.
The penalties for failing to complete and file T1135 by the due date (April 30) are severe. The penalty for filing late is $25 per day for up to 100 days (maximum of $2,500). Since the penalty is levied for each year, a taxpayer could face penalties running into the tens of thousands of dollars.
Some notes about Form T1135:
– If you own foreign stocks in joint investment accounts, you should file Form T1135 only if the cost of your share of the investments exceeds $100,000.
– Canadian mutual funds and ETFs that own foreign stocks or ETFs are not considered “specified foreign property”.
– Foreign stocks and ETFs held in registered accounts such as RRSPs and TFSAs are also not considered “foreign property”.
– As already mentioned, real estate owned in foreign countries and held strictly for personal use are not considered “foreign property”.
It is entirely appropriate to levy strict penalties on taxpayers trying to hide income in foreign jurisdictions. It does not seem reasonable to levy stiff penalties on taxpayers who are reporting and paying taxes on investments held in Canadian accounts but inadvertently missed filing paperwork. In fact, the punishment strikes me as cruel and unjust.
NB: This post is of an informational nature and should not be construed as tax advice.