Employee Stock Options

FORUM Magazine

2008-01-01



The unequal tax treatment of capital losses

By Jamie Golombek

It's now been just over one year since a small group of former SDL Optics Inc. (since acquired by JDS Uniphase) employees based in Saanich, B.C. cut a special, exclusive deal with their local MP, federal Minister of Natural Resources Gary Lunn.

In December 2006, Mr. Lunn revealed that his government would be forgiving all taxes and interest for a group of workers who were forced to pay taxes on their employee stock purchase plan (ESPP) gains.

As Minister Lunn, who is the MP for Saanich-Gulf Islands (where the now-defunct JDS plant was located), stated at the time: "It took a change in government to get someone to listen, but the prime minister has come through and delivered tax relief on this issue".

The issue affects many employees across Canada who participated in stock purchase plans or exercised employee stock options only to find the price of the shares plummet thereafter.

Under Canadian tax law, if you purchase shares though 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 subsequently decline in value between the date you ultimately sell them and the date you received 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, such as those at the Saanich JDS plant, who face massive tax bills on money they never "received".

The JDS employees paid about $3 for their stock, which was valued at over $300 when issued. The price of shares plunged with the technology meltdown of 2000, leaving workers who did not sell their shares upon receipt with a huge tax bill and nearly worthless stock.

Years of lobbying by former JDS employees to fix this tax problem fell on deaf ears and some of the affected employees were forced to take out second mortgages and lines of credit to be able to meet the demands of the Canada Revenue Agency's (CRA) collection department.

Finally, in December 2006, the government forgave the tax, along with any interest, owing. "It's not in the interest of government to tax people on money they never saw", said Mr. Lunn. Great news if you were one of the affected JDS employees, but of little benefit to employees of other companies.

The fact that the investor didn't sell the shares immediately, however, is the main reason why the CRA has traditionally had little sympathy for such employees. The CRA believes that the tax system was indeed fair and "reflects the result that, at the point of acquisition, those employees who hold their shares have chosen to accept a market risk, as an investor, in the expectation of a return on that investment, including the future appreciation in the value of those shares. Thus, they are subject to the same general income tax rules respecting capital gains and losses on the underlying shares as other investors".

Whether or not you agree with this position, it's outrageous that the CRA is cutting special deals for only limited groups of employees.

The details of the remission order relating to the 35 ex-employees of JDS who were granted special relief was published in November 2007 in the Canada Gazette, the "official newspaper" of the Canadian government.

The order lists the names of each employee, along with the amount of tax and/or interest that was forgiven. The amount of tax forgiven ranges from $183.47 for Pamela Shwab to over $183,000 for Christine Mollerud. The government also forgave large amounts of arrears interest, including over $179,000 accruing to Ms. Mollerud.

While the remission order may be of huge relief to those 35 employees whose taxes and interest were forgiven, it does nothing for the estimated tens of thousands of employees across Canada in similar situations.

It's high time the government stood up and made a retroactive legislative change for all affected employees. Otherwise, it can be truly said that in Canada, the squeaky wheel gets the grease.