Release date: May 21, 2013
Guest: David de Souza
Running time: 10:50 minutes
In this episode of Tax Tracks, David de Souza discusses payroll issues for cross-border employees related to incentive compensation.
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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: Hello — This is Sharon Mitchell of PwC Canada, and welcome to the second instalment of our "What if" series addressing payroll issues for cross-border employees receiving incentive compensation. With us today is David de Souza – he is a senior manager in our Toronto office who assists employers, employees, and other individuals to manage the global taxation issues resulting from cross-border travel.
David: Thank you Sharon — it’s a pleasure to be here today.
Sharon: David, in a previous podcast, I interviewed your colleague Carola Trolley and we explored some of the Canadian payroll issues related to income from stock options when an employee works in different countries. I know that stock options are not the only type of incentive compensation offered by employers — what else could an employee receive that could have future cross-border tax consequences?
David: To be honest, each employer has its own terminology for their incentive compensation plans, such as MTI, LTIP, DSU, and RSA, however these plans are generally designed to provide an employee with cash or shares at a future date. The employer’s objective is to retain top performers by providing compensation that is only paid based on the individual’s ongoing employment with the company or their achievement of the company’s targets. A compensation plan can be as simple as a deferred bonus, or a more complex structure that includes restricted stock, deferred units, and the like.
Sharon: Now what makes the payroll issues for these awards different from what employers need to consider when stock options are exercised?
David: A stock option exercise is a relatively straight-forward transaction from an income tax perspective — an employee has the ability to acquire a number of shares of the company in the future at a price established when the award is granted. The resulting income at the time of exercise could then be taxable in one or more tax jurisdictions based on where the employee has resided and worked between the date of grant and the date of exercise, or where they resided on the dates of grant, vest, or exercise. Most industrialised countries tax the stock option benefit in the year the options are exercised, and there are usually no tax implications if the options lapse without being exercised.
In comparison, other mid-term or long-term deferred or restricted compensation is delivered once certain criteria are met, as detailed in the award plan document. An employer’s tax withholding and reporting obligations differ based on the countries involved, and a review of the plan document is often required to determine the correct allocation of the income between each jurisdiction. Some countries, including Canada, may tax defer compensation in the year the award is granted, even if the employee does not receive the cash or shares until a future year. This has the potential to create double-tax situations if the employee lived in such a country when the award was granted, but lived in a country that taxed the income at the date of vest when the cash or shares are distributed.
Sharon: Wow — I’m sure such a situation could pose a potential stressful situation for an individual if the tax issues were not identified in advance when the awards were issued, or when the employee relocated to another tax jurisdiction.
David: That’s absolutely correct Sharon. It’s unfortunate, however we do see instances where tax advice was not provided to a client when the awards were granted, and we uncover the differences in global reporting at the time the award vests, or worse, when the tax returns are being prepared. Belgium is one of the countries that taxes certain incentive compensation at the date of grant, whereas the compensation from the same award could be taxed in Canada at the date of vest. There isn’t always an opportunity to claim foreign tax credits and avoid a double-tax situation, and the employee could end up paying 80% overall income tax or more on an award.
Sharon: David, what are the critical considerations for employers when granting incentive compensation to employees who perform cross-border services or who could potentially be required to do so in the future?
David: Employee mobility is greater today than it ever has been — we have the technology to perform our employment duties almost anywhere in the world, and potential cross-border tax issues should be considered regardless of whether or not there is current cross-border travel for employees receiving incentive compensation. When incentive compensation plans are created or amended, a statement affirming the employee’s responsibility to understand future tax implications is an initial step that could have future benefits to the employee and employer. When an employee starts working in another tax jurisdiction, either by way of personal choice or employer-initiated assignment, consideration should be given to awards that have not yet vested or which may be granted in the future. Open dialogue between the employee, employer, and their tax advisors will promote the understanding of expected tax issues, and it will decrease the likelihood of future tax surprises.
Sharon: In that case, is there anything specific to Canada that would cause difficulties to employers for individuals who were granted awards in Canada which vested in another country, or vice versa?
David: Yes Sharon, by way of background, Canadian income tax regulations require Canadian income tax to be withheld on compensation paid to a resident of Canada, or on to the Canadian-source portion of compensation paid to a non-resident of Canada. You could have an individual whose long term compensation vests while they are resident in Canada but part of the income relates to employment services provided outside Canada. In such a situation, the Canada Revenue Agency requires full Canadian income tax withholding unless the individual applies for a reduction of income tax withholding and this application is approved by CRA. In the application, the employee would have to demonstrate that the full award should not be subject to Canadian withholding, such as in a situation where the employee will be liable to pay foreign tax on the foreign source portion of the award, and a foreign tax credit will be claimed when the individual files his or her Canadian income tax return. If the withholding waiver application is not filed and approved prior to the date the award is paid out or the shares delivered, the employer is required to withhold and remit Canadian income tax on the full award.
Regulation 102 within the Canadian Income Tax Act states that compensation paid to non-residents of Canada with regard to employment services provided in Canada is subject to Canadian income tax withholding. This applies to individuals in a situation opposite from the one above — where they were resident in Canada at the time the award was granted and the award vests when they are resident in another country. Cash could be paid fully from the other country, however Canadian income tax would have to be withheld and remitted to the Canada Revenue Agency on the Canadian-source portion of the income. Preparation of payroll reporting documents, such as the annual employee T4 slip, is also required.
Sharon: David could you take us through an example of when things go right and what can happen if employers are not compliant?
David: Great idea Sharon. As an example, let’s take a CFO of a public company in Canada who plans on making a permanent move to Australia in July of the current year. He receives his annual bonus in December, a portion of which must be deferred for three years as stock units, otherwise known as DSUs or deferred stock units. He also receives restricted stock awards (or RSAs) as incentive to stay on with the company. These RSAs will be awarded if the company exceeds certain performance targets. Lastly, due to the permanent move, the CFO is responsible for paying all of his world-wide income tax liabilities personally.
In order for reporting and remittance obligations to be properly satisfied, it is key that both the company and the CFO understand how these types of compensation items are taxed in each jurisdiction, as well as, an understanding of the CFO’s residency in each location.
In this specific case, the CFO would have continued Canadian tax filing obligations for those amounts granted to him before he left Canada. In addition, the payouts would likely be taxable in Australia as well, should he receive them in Australia while resident or a portion of the equity compensation is considered Australian source.
For the restricted stock awards, the restricted stock award plan would have to be reviewed from a tax perspective to understand whether the taxable event in Canada and Australia occurs at the date of grant or the date of vest, and whether this new plan would be efficient for the CFO and the company if there were significant adverse tax timing differences.
From an employer perspective, non compliance can mean penalties and interest charges for failure to withhold tax and report income in both home and foreign locations. As a result, it’s important to understand your exposure in each tax jurisdiction so as to mitigate potential exposures.
Sharon: What recommendations do you have for employers who grant mid or long-term compensation and have mobile employees?
David: Global coordination with compensation and payroll groups in other countries can be a challenge, especially if the company’s operations are independent in each country, and there is little communication across borders. The key is to understand what compensation plans exist and which employees are granted awards under these plans, and then to develop procedures where information is regularly shared. As a further step, employees with cross-border travel need to be identified — this was discussed in detail during our recent Frequent Business Traveller podcast series.
Sharon: David, thank you for walking us through some of the issues related to cross border taxation of incentive compensation.
David: My pleasure Sharon.
Sharon: For our listeners the aforementioned Frequent Business Travellers podcast series as well as David’s contact details can be accessed at 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.