Change in position on allocation of cross-border stock option benefits

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Episode 54: Change in position on allocation of cross-border stock option benefits

Release date: Febuary 22, 2013
Guest: Chantal McCalla
Running time: 7:30 minutes

In this episode of Tax Tracks Chantal McCalla discusses the recent changes to the allocation of stock option income accepted by the CRA.

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Change in position on allocation of cross-border stock option benefits

You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.

Sharon: Hi, this is Sharon Mitchell of PwC Canada and this is a podcast on the recent changes to the allocation of stock option income accepted by the Canada Revenue Agency. With us today is Chantal McCalla, a senior manager in our Toronto office. She specializes in the human resource challenges faced by both inbound and outbound international assignees.

Welcome Chantal

Chantal: Thank you Sharon — it’s nice to be here.

Sharon: Chantal, can you give us a high level introduction of the Fall 2012 changes related to stock option allocation?

Chantal: Sure Sharon, what‘s happened is that Canada Revenue Agency (CRA) recently confirmed that it will apply the principles set out in the Commentary on Article 15 of the OECD Model Tax Convention on income and capital, when allocating a stock option benefit to Canada. That is, unless an income tax treaty otherwise specifically applies. This OECD model convention provides guidance to countries to help resolve issues involving international double taxation and forms a starting point for tax treaty negotiations between countries. This change applies to stock option exercises after 2012.

Sharon: Chantal what was the previous accepted allocation before this change?

Chantal: Well, the CRA's long-standing view has been to allocate the benefit to the services rendered in the year of grant, unless there is compelling evidence to suggest that some other period is more appropriate. In contrast, from 2005 onwards the OECD guidance has advised that the key is to determine the amount of the benefit that is derived from employment exercised in the source country, looking at all relevant facts and circumstances. In many country cases this would be the period of grant to vesting of the options.

Sharon: I see, so historically, then, was there any disadvantage to sourcing the stock option to the services rendered in the year of grant vs. the applicable countries where services were performed over different periods, such as grant to exercise or vesting?

Chantal: Yes exactly Sharon there certainly could be, you see CRA’s default position can lead to potential double taxation when there is no foreign tax credit relief or other relief available under an income tax treaty depending on the other foreign jurisdictions involved and their own view on sourcing.

Sharon: So I presume then that the change alleviates the risk of double taxation. Can you tell us a little bit about how one applies these changes?

Chantal: Sure. To your first point, you are correct. This change helps reduce the ambiguity around the sourcing of stock options and as you mentioned, alleviates the risk of double taxation. It brings Canada’s default position in line with the OECD model convention guidance and therefore many countries’ approaches around the world.

To be specific, the CRA summarized the OECD principles as follows:

The determination of the amount of a stock option benefit that is derived from employment exercised in a source country must take into account all relevant facts and circumstances, including underlying contracts. In particular, a stock option benefit is apportioned to each source country based on the number of days of employment exercised in that country over the total number of days in the period during which employment services from which the stock option benefit is derived are exercised.

Generally, a stock option benefit is presumed to relate to the period of employment that is required as a condition for the employee to acquire the right to exercise the option i.e. the "vesting period" and a stock option benefit is generally assumed not to relate to past services, unless there is evidence indicating that past services are relevant in the particular circumstances.

On this basis, the result is a better matching of foreign tax credits for cross-border stock options.

Sharon: Ok I think I understand, can you give us an example of how these principles have changed the stock option allocations.

Chantal: Sure, let’s say I have a Canadian resident for tax purposes, who is granted a stock option while a resident of Canada and that individual goes on an assignment to the US and then from the US to South America in subsequent years but remains a resident of Canada during all of this time period. As a continuing resident of Canada this individual is taxed on 100% of the stock option benefit. In this case, the individual has a stock option whose grant to vest period spans the assignment period. That individual may be subject to tax in both the US and South America on the stock option exercise. In the absence of evidence to the contrary, Canada would have previously sourced the stock option to the services rendered in the year of grant, in this case Canada, leaving no ability to claim the foreign tax credit on the Canadian return for potential for US and South American taxes paid. With the new guidance in place, that individual can now source the stock option benefit over the three countries employment service and claim the foreign tax credit on the Canadian return for US and South American taxes paid.

Sharon: Thanks for that detailed explanation Chantal. Are there any possible exceptions to this new guidance?

Chantal: Great question Sharon. As the OECD Model Convention states, there could be circumstances where a different allocation period than grant to vest is appropriate, such as past services, but the option contract would need to clearly stipulate that. CRA also notes that where the terms of the option indicate that the grant is treated as a transfer of ownership of securities, the CRA may attribute the benefit accordingly (i.e. sourced to the location at grant). Circumstances noted as indicative of a transfer of ownership include where the options were in-the-money or where they are not subject to a substantial vesting period.

Sharon: So Chantal, in the end, what’s the bottom line?

Chantal: In the end Sharon, this latest announcement allows both the employer and the internationally mobile executive greater certainty with respect to the proper allocation of their cross-border stock option benefits for Canadian tax purposes and it helps alleviate the potential for double taxation, as it brings Canada’s approach in line with the prevailing view of many countries around the world.

Sharon: Thank you Chantal for this informative discussion on the recent changes to stock option benefit allocations in Canada.

Chantal: My pleasure Sharon.

Sharon: Should you have any questions related to this topic, Chantal’s contact details can be found on our PwC podcast website www.pwc.com/ca/taxtracks.

The information in this podcast is provided with the understanding that the authors and publishers are not herein engaged in rendering legal, accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.