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the global equity equation a global equity services blog menu skip to content home about our practice contact search search for: not so fast: tax deduction for share-based awards in canada july 9, 2018 / barbara klementz after discussing the issues for a tax deduction for share-based awards in israel in my last blog, i wanted to revisit another tax deduction conundrum, this time in canada. in the past, the canada revenue agency (cra) generally has not allowed a local tax deduction for the cost of share-settled awards (other than under very narrow circumstances). however, based on a technical interpretation released on april 12, 2017, the cra updated its position such that a company should be entitled to a tax deduction for the cost of awards if: it retains the discretion to determine whether the award will be settled in cash or shares; it does not commit to delivering the shares at any time before settlement; it actually delivers shares upon settlement; and where the award is granted by a non-canadian parent company, the canadian entity reimburses the parent for the cost of the award. based on this interpretation, most companies should be able to obtain a tax deduction in canada for (time-based or performance-based) rsus granted under the above conditions. by contrast, it would be more difficult to structure an option or purchase rights granted under an espp as being able to be settled in cash or shares.¹ but even for rsus, companies will need to consider two issues before restructuring their awards to be settled in cash or shares to obtain the tax deduction. first, companies will need to confirm with their accountants whether retaining the discretion to settle the award in cash or shares will subject the award to liability accounting, i.e., mark-to-market accounting (rather than (fixed) equity accounting). liability accounting can introduce greater volatility for the balance sheet, but depending on the number of awards granted in canada, this may not be material for most companies. second (and probably more importantly), if the award can be settled in cash or shares, it will be subject to the salary deferral rules, which is canada’s version of section 409a (sort of). if an award runs afoul of the salary deferral rules, it is taxed at grant, and not only when the shares are issued, which is obviously a very undesirable outcome. an exemption to the salary deferral rules exists, but is often described incorrectly as applying if an award is fully vested at least by the third anniversary of the grant date. therefore, it is assumed that awards that vest pro-rata over a three-year period from the grant date or awards that cliff-vest on the third anniversary of the grant date are fine. however, the three-year vesting exemption from the salary deferral rules is a bit more nuanced. in particular, it applies only if the award is fully vested within three years after the end of the year in which the services were rendered for which the award is granted . for example, if a company grants an award in february 2017 (at least partially) for services rendered in 2016, the award would have to be fully vested by december 31, 2019 to avoid taxation at grant (i.e., less than three years from the grant date). the question then becomes if or when awards are granted in consideration for services rendered before the grant date. for new hire awards, it should be relatively easy to argue that the awards are not granted to reward past performance, in which case it will be sufficient if the awards are vested by the third anniversary of the grant date. however, for refresh grants, this argument is more difficult to make, and there is an inherent assumption that awards made to existing employees are made to, at least in part, reward past performance. this becomes even more clear if a company determines the size of the refresh grant (again, at least in part) based on prior year performance. consequently, granting awards that can be settled in cash or shares to obtain a tax deduction in canada may require additional changes to the award terms to avoid running afoul of the salary deferral rules, i.e., shortening the vesting schedule (in some cases, quite significantly). given the above, before rushing into relying on the cra interpretation to take a tax deduction in canada, companies should carefully consider if retaining the discretion to settle the award in cash or shares makes sense in light of the challenges posed by the salary deferral rules. ¹ for options, it is also important to point that, even if companies are able to retain discretion to settle the option in cash or shares, such discretion will eliminate the 50% tax exemption that otherwise applies to options. therefore, going this route for options is hardly going to be popular with employees. tax deduction and other troubles in israel june 13, 2018 june 14, 2018 / barbara klementz i hope most of you have seen our client alert on the recent israeli supreme court ruling that confirmed that stock-based compensation has to be included in the cost base of israeli subsidiaries of multinational companies. as a result of the decision, we have already seen a flurry of activity as many companies are evaluating how to obtain a tax deduction for awards granted to israeli employees. as a reminder, for companies with a cost-plus arrangement with their israeli subsidiary, the decision means that the income of the israeli subsidiary is effectively increased by the amount of the stock-based compensation, plus the mark-up. to mitigate the tax due on this increased income, it will be crucial for most companies to deduct at least a portion of the equity award income. the problem is, however, that a tax deduction for equity award income is available in israel generally only for awards granted under a trustee plan. many companies have already set up a trustee plan to grant awards in israel because trustee awards can provide for beneficial tax treatment for the employees and, thus, most israeli employees push hard to receive trustee awards. so let’s look more closely at the requirements of a trustee plan and the corresponding tax benefits. trustee plan requirements as the name indicates, a trustee plan has to be administered by an israeli trustee which has to hold the awards and underlying shares for the duration of the holding period (more on this below), and which will satisfy the applicable tax withholding and reporting obligations. most companies enter into a “supervisorial” trust arrangement with the trustee, which means the awards and shares are not physically held by the trustee. instead, they are held by the existing broker ( e.g. , in the u.s.) and the israeli trustee works with the broker to ensure the awards/shares are not sold before the holding period ends. there are a number of companies in israel which can act as a trustee for this purpose, and several are very familiar with u.s.-style equity plans and can work with the brokers that generally administer the plans. the fees vary by trustee, and usually depend on the number of grantees in israel and the number of transactions. further, to implement a trustee plan, an israeli sub-plan to the parent plan will need to be adopted and filed for approval with the israeli tax authority (“ita”). once the initial filing has been made, companies must report each grant to the trustee within 45 days of the grant date. this can be done by sending the trustee a copy of the board resolutions approving the grants. there are two possible tracks for a trustee plan: the capital gains track and the ordinary income track . almost all companies we work with opt for the capital gains track because only this track also provides tax benefits for the employee. capital gains track under the capital gains track, employees will be taxed at sale on the sale proceeds minus any price paid by the employee to acquire the shares ( i.e. , exercise price for options, purchase price under an espp, nil for rsus). for
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