Backdating of executive
For options issued by a public corporation, one-half of the stock option benefit is deductible under paragraph 110(1)(d) if three conditions are met: (1) the option strike price is equal to or greater than the fair market value of the share at the time of the grant; (2) the optioned shares are “plain vanilla” common shares; and (3) the employee deals at arm’s length with the employer. In addition, for options issued by public corporations after February 27, 2000, and exercised prior to p.m. are met: (1) the recipient is a Canadian resident; (2) the underlying shares are traded on a Canadian or foreign prescribed stock exchange; and (3) the individual is entitled to the deduction under paragraph 110(1)(d). The deferral, however, is limited to the first 0,000 worth of options per year of vesting. (EST) on March 4, 2010, the employment income benefit is deferred until the time the shares are sold if the following conditions, stipulated in subsections 7(8) to (16) of the I. In the United States, the taxation of employee stock options depends on their characterization as non-statutory stock options (“NSOs”) or statutory stock options, which includes incentive stock options (“ISOs”) and employee stock purchase plans (“ESPPs”). There is no difference in the treatment of options granted by a public corporation and a private corporation. In order for an option to be treated as an ISO, a number of requirements must be met including: (1) the exercise price must not be less than the fair market value of the stock at the time of the grant; (2) the exercised shares must be held for the longer of two years from the grant date or one year from the exercise date; and (3) the combined value, as determined by the fair market value of the underlying shares on the grant date, that can be acquired for the first time in any calendar year (i.e., in the year of vesting) cannot exceed US 0,000. For an ISO, there are no income tax consequences until the time the shares are sold, unless the Alternative Minimum Tax (“AMT”) applies. Thus, a taxpayer must pay the greater of (i) his or her regular tax liability or (ii) his or her tentative minimum tax liability, calculated under the AMT rules. This paper contrasts the post-tax returns of backdated at-the-money options to currently-dated in-the-money options (with the same strike price as the backdated options) and demonstrates that a Canadian executive can earn a significantly larger after-tax return from backdated options compared to a US executive. We tie this to the favorable Canadian tax treatment of executive options relative to their treatment in the United States. In Canada, not only is there no super-inclusion or penalty tax regardless of the option’s exercise price relative to the value of the shares on the option grant date, but also provided that the options are at-the-money (or backdated to appear as such), only one-half of the option benefit is included in income for tax purposes regardless of the length of time that the shares are held after exercise. This demonstrates a clear tax advantage for stock option compensation, provided that the options are granted not-in-the-money (or reported as such). § 409A should have reduced the incidence of backdating in the United States. An executive at a publicly traded company is the recipient of an option grant for 30,000 shares which expires ten years after the date of the grant. § 409A. For the purposes of demonstrating the impact, if any, of minimum tax in Canada and AMT in the United States, it is assumed that the executive has gross taxable income not derived from any issuance, exercise or sale of stock options or the underlying stock, of 0,000 and does not benefit from any tax preference other than the preference (if any) associated with employee stock options. For a Canadian executive, if the option is “successfully” reported as an at-the-money grant awarded on October 16 with a strike price of .25, then the income benefit subject to tax is calculated as the difference between the fair market value of the shares on the date of exercise and the strike price multiplied by the number of options awarded, which is 5,600.
Personal income taxation of stock options in Canada is notably less complex and more generous from the employee’s perspective than in the United States. The AMT rate for individuals is 26% of such amount up to 5,000 and 28% of any excess. S. It is important to understand the differences in these rules, particularly the extent to which these differences affect the after-tax return to a Canadian executive compared to a U. Part II considers these personal income tax rules in detail. For individuals, the exemption amount depends on whether the individual is married and filing a joint return (in which case the amount is ,000) or is a surviving spouse (,000) or is single (,750). In particular, the relevant personal income tax rules in the two countries are compared and contrasted to demonstrate the role these rules may play in determining the demand for backdated options in the two countries. As will be shown, this is potentially an important component in the decision of executives to accept backdated stock options and may provide an additional incentive for executives to demand them in Canada. Second, upon the sale of the stock acquired pursuant to the option, the difference between the proceeds of disposition of the stock and the fair market value of the stock on the date the option is exercised is taxed as a capital gain or capital loss, as the case may be. One exception concerns stock options granted by a Canadian-controlled private corporation (“CCPC”). To be precise, the AMT imposed is the amount by which the tentative minimum tax liability exceeds the regular tax liability. The tentative minimum tax liability is calculated by recomputing regular tax liability, first by adding back to taxable income tax preference items and by making certain adjustments in order to determine the alternative minimum taxable income (“AMTI”), then by applying the appropriate AMT rate to the amount by which AMTI exceeds the taxpayer’s exemption amount. Under subsection 7(1.1), if certain conditions are met, the inclusion of the employment income benefit is deferred until the time that the shares are sold. In addition, there is a deduction equal to one-half of the inclusion if either the option strike price is equal to or greater than the fair market value of the share at the time of the grant (section 110(1)(d)) or if the shares acquired on exercise are held for a minimum two- year period before sale (paragraph 110(1)(d.1)). As the backdating scandal mainly involves public corporations, we do not consider the tax treatment of options issued by CCPCs further.