“What If” – Payroll issues with respect to expatriate’s stock option grants

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Episode 56: “What If” – Payroll issues with respect to expatriate’s stock option grants

Release date: May 7, 2013
Guest: Carola Trolley
Running time: 8:13 minutes

In this episode of Tax Tracks, Carola Trolley explores payroll issues with respect to expatriate’s stock option grants.

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“What If” – Payroll issues with respect to expatriate’s stock option grants

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, it’s Sharon Mitchell; welcome to our “What if” podcast series that discusses various tax situations and issues with the Canada Revenue Agency. Today we have Carola Trolley, a Senior Manager from the PwC Human Resource Services tax group. Carola specializes in International Assignments and Expatriate Tax Management at PwC and has been working in this field for many years.

Welcome Carola.

Carola: Thank you Sharon, it’s great to be here.

Sharon: Now Carola, it’s my understanding that when a company is required to pay out any long term incentive amounts to either current expats or former expats, there are some payroll complications that need to be considered? Could you elaborate on what those are?

Carola: Sure Sharon. Well, all too often we get this question after the fact, or when returns need to be filed, so by actually being proactive, we can avoid some significant issues, both for the company and the employee.

So specifically, we see this issue when a company has a stock option plan with let’s say a 10 year window, they’ve had financial success over a specific year or years and in this case, there may be employees with old grants that choose to exercise their stock options due to a favourable stock price. These individuals may include the more senior employees or executives that have had a significant amount of out of Canada business travel. As a result of that travel, there could potentially be payroll reporting and income tax remittances in various countries depending on where the employees’ travel patterns have been.

Sharon: Carola, I think it would be helpful if you could take us through a specific example to provide us with some clarity regarding the issue.

Carola: That’s a great idea Sharon!

Ok, so let’s say we have an employee who was granted options in 2004, and at the time he was living and working in Canada. Now these options vest 20% over five years and have a 10 year life. Now in 2006 he moves to Ireland and he worked there for 2 years and then moves to Australia. He is now scheduled to move back to Canada in 2013.

So as a preface to the issue, it is important to understand the taxation of the option exercise that often drives a payroll. Specifically, you need to understand how countries look at stock options in particular. There are several “periods” we look to in determining the “source” of the income. The “source” of the income is generally what countries will then look to when determining how much of the total employment benefit they are entitled to tax. So generally there is the period between grant to exercise or a period between grant to vest.

So just to clarify, we would need to allocate the total benefit the employee receives between 5 periods. We’ve got 2004-2005, 2004-2006, 2004-2007, etc. Now, depending on the workdays in each of these periods, the income would be sourced based on workdays spent in the locations during each period, say, from grant to vest.

So in our example, up until 2006 all of the employee’s workdays were in Canada. So the first 20% would be 100% Canadian source. For the 20% vesting in the period 2004-2006, a portion is sourced to Canada and then also portioned to Ireland because he was in two different locations during that sourcing period. For the sourcing period 2004 to 2008, he may actually have three different locations to source the stock option exercise over. Does that make sense?

Sharon: Ok, now I do see how the vesting period works and that you need to look at the locations he was in during those vesting periods to determine where to source the income. My question is, if the company is paying the long term equity awards all out of Canada, how do they manage this from a payroll perspective so the employee has the right withholding and the company does the right reporting?

Carola: That’s actually an insightful question Sharon. The first step is for us to gather all the information – so, the grant date, the vest date, date of moves, workday information from the employee, things like that. Then we can prepare a summary with percentages of how much of the net benefit is to be taxed or reported in each country. We can show the company how much is to be withheld from the employee, and how much tax should be remitted to each country. If the preference is to keep the net payout to the employee all on the Canadian payroll, then we can do some shadow payroll reporting for the other countries - similar to what companies may be doing for their current, active expats.

Sharon: That’s great Carola, it sounds like companies that track this information can easily manage the reporting and remittance requirements in various locations. I was wondering though, what happens if countries have different sourcing periods?

Carola: Another great question Sharon. There is a possibility that different sourcing periods can lead to double taxation. So it would be important for the company to consider the proper sourcing methods in the jurisdictions employees travel to on assignment or otherwise and include that in any analysis.

Sharon: Ok, so now I know all about sourcing of compensation. Could we take a minute to explore the payroll reporting requirements?

Carola: Sure. First, for employees, that are currently resident in Canada at the time of exercise, the employer does have an obligation to report the full benefit on a T4 and regular withholding applies to 100% of the equity award. Now you can see that for the resident, to have withholding applied to 100% of the award it could potentially by punitive – particularly in situations where taxes are also due to another country. For these situations, Canada Revenue Agency has a process whereby the employee can apply for a waiver of the taxes to be withheld in consideration of any foreign taxes required to be paid on the same income. I believe this waiver process is going to be discussed in a future webcast. Of course, any amounts paid from Canada that are considered Canadian source that will require the company to remit actual taxes on that portion of the option exercise.

Now for those employees not resident at the time of exercise, the employer should split the equity award between the Canadian and other country source portions and report the appropriate portions on both a resident and non-resident T4. Administratively, CRA doesn’t require withholdings on non-resident source income paid to a non-resident of Canada.

From a foreign location perspective, the company should consider setting up shadow payrolls in the applicable locations to ensure the proper reporting of compensation and remittance of tax is adhered to.

Sharon: Thank you Carola for taking us through this detailed discussion as it relates to stock option grants and exercises. I imagine that this also extends to other equity compensation vehicles?

Carola: Absolutely Sharon. I believe the next podcast in this series will address that very topic.

Sharon: Great! For any follow-up questions, Carola’s contact details will be available on our PwC podcast website www.pwc.com/ca/taxtracks.

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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.