Moore Canadian Overview

Q2 2024 Moore Canadian Overview

Moore Canadian Overview
As an independent member of Moore North America, we are proud to share the Moore Canadian Overview. This quarterly newsletter is a collaborative publication, created by Segal and our fellow Canadian member firms of Moore North America. Each edition offers a selection of articles covering a range of current topics designed to inspire conversation. We invite you to take advantage of this valuable resource.

Alternative compensation strategies to attract and retain talent

Considering the significant expense of recruiting and training employees, employers are increasingly motivated to structure compensation incentives that will not only attract top candidates, but retain them for the long term.

Strategies such as providing a supportive onboarding process, pairing new employees with mentors, conducting regular performance reviews, showing appreciation by acknowledging hard work and encouraging work‑life balance are all important elements.

But in today’s competitive market for talent, it is essential to also consider the optimum financial compensation strategy. Here, we look at a few value‑focused ways employers can compensate potential hires beyond high base salaries and benefits.

Equity‑based compensation

While smaller companies are limited when it comes to paying higher salaries, they can offer employees attractive alternative opportunities to participate in the company’s future. These are generally equity participation plans with no tangible value until they are vested. Large companies often find stock‑based plans to be an effective tool in motivating their employees, as it aligns the employee’s interests with those of the company, and the value of their efforts can be readily measured.

There are many variations in equity‑based compensation plans. These include the vesting schedule, definition of liquidity events, what happens if an employee leaves the company after options have vested and before the liquidity event, as well as other considerations. The appeal of the different plans may depend on the tax implications to both the employee and employer.

Equity‑based compensation has become commonplace as such compensation is based on an increase in the company’s share value, thereby incentivizing employees to put in greater effort to increase this value.

Stock options and warrants

Stock options or warrants are the most common non‑cash compensation plan. An employee is given the right to buy or sell the company’s stock within a certain timeframe for a specific price.

A call warrant or option grants the right to purchase shares at a specified strike price. A put warrant or option grants the right to sell the shares back to the company at a predetermined price. Each type has its own strategic implications and can be valuable, depending on the employer’s and employee’s outlook on the company’s future performance. While options and warrants have technical and legal differences, the tax implications may be similar if they are in essence received by virtue of employment.

When an employee exercises a call option, the benefit is taxable to the employee as employment income if the employee is given the right to purchase shares of the employer or a non‑arm’s length party. The benefit is also deemed to have been received if the employee transfers or disposes of rights under the agreement.

The taxation of the benefit will depend on:

  • The value of the shares at the time the options are granted;
  • The value of the shares at the time the options are exercised;
  • Amount paid by the employee for the shares (i.e., the strike price); and
  • Amount, if any, paid by the employee for the option

Generally, the employee is considered to have received a taxable benefit when the employee exercises the option and acquires the shares. The taxable benefit is the difference between the value of the shares when the employee acquired them and the amount paid for the shares, including any amount paid for the right to acquire the shares. The employee may deduct half (one‑third after June 25, 2024) of the taxable benefit if:

  • The share issued is a common share
  • The value of the share when the options are granted did not exceed the exercise price, and
  • The employer and employee are dealing with each other at arm’s length at the time the option agreement is entered into.

There is a limit of $200,000 annually of options that have vested if the employer group has revenues exceeding $500 million.

If the employer is an arm’s length Canadian‑controlled private corporation, the taxable benefit is deferred until the employee disposes of the shares. The half deduction is available if the employee holds the shares at least 2 years before selling. The stock option deduction is one‑third of the benefit if the stock option is exercised on or after June 25, 2024, or in the case of a Canadian‑controlled private corporation, when the share is sold. The deduction may be increased to half on up to a combined $250,000 for employee stock option benefit and capital gains. If the total combined employee stock option benefit and capital gains exceed $250,000, the employee may choose how to apply the $250,000.

If an employee has realized a capital gain of $125,000 and stock option benefits of $200,000 in 2025, the amount taxable at two‑thirds will be $83,333 of capital gain and $133,333 of stock option benefits.

The employee may elect to claim $200,000 of stock options and $50,000 of capital gain to be taxable at half deduction, or claim $125,000 of capital gain and $125,000 of stock options to be taxable at half deduction

An employee may receive cash instead of the shares in exchange for the option. The employee can claim the half (one‑third after June 25, 2024) deduction if eligible, or the employer can claim the cash payment as an expense, but not both.

If the employer chooses not to claim the cash‑out as an expense, the employer must elect to do so under subsection 110(1.1) of the Income Tax Act by entering this amount under code 86 ⁠–⁠ “Security options election” ⁠–⁠ in the “Other information” area of the T4 slip. This allows the employee to claim the deduction under paragraph 110(1)(d). The amount you report under code 86 may differ from the taxable benefit you must include in the employee’s income in box 14 and under code 38. If code 86 of the T4 is not entered, this indicates the employer chose to claim the expense, prohibiting the employee from claiming the deduction under paragraph 110(1)(d).

Restricted stock units

Restricted stock units (RSUs) are issued to employees through a vesting plan and distribution schedule after certain performance or service milestones are met. For example, an employee of a startup company may not receive shares as RSUs until and unless the company issues its initial public offering. Normally, no discretion or cash payment is required by the employee. RSUs are considered income once the conditions for vesting are met. Often, a number of the vested shares (if publicly traded) will be sold to cover the tax bill and the employee will only receive the balance of the shares.

Phantom stock plans

Phantom shares are a type of compensation where employees receive notional shares in the company on an established vesting schedule. Unlike RSUs, they do not provide ownership rights of actual shares. Instead, the value of the phantom stock units are tied to the company’s share value and, when vested, will be paid out in cash. For example, if an employee is awarded 100 shares when the share value is $10, and the value of the shares becomes $40 per share when vested, the benefit received is $4,000.

Stock appreciation rights

Stock appreciation rights (SARs) give employees the right to receive an amount equal to the increase in value of a set number of shares without owning them. The employee will receive a payout equal to the increase in share value. This is similar to a phantom stock plan, except it provides the right to the monetary equivalent of the increase in value of a specified number of shares over a specified time period. Using the same values as above, the employee can expect a benefit of $3,000 [($40 ‑ $10) x 1,000] at vesting.

Salary deferral arrangement

In planning equity‑based compensation arrangements, it is important to understand the salary deferral arrangement (SDA) rules. An SDA is a plan or arrangement under which an employee has a right to receive an amount in a future year where it is reasonable to consider one of the main purposes of the right is to postpone tax payable on salary or wages for services rendered by the employee in the year or a preceding taxation year. Under an SDA, the employee is taxed in the year the amount is earned.

Wondering which compensation strategy is right for you? Segal’s experts can help determine the best plan to implement, ensuring it meets the objectives of both your business and your employees.

It pays to understand compensation

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This year’s charity ride was a real team effort

Toronto, ON – On June 2, a team of 17 intrepid cyclists from Segal took part in the Bike for Brain Health charity ride as team SG Peloton. It was an unforgettable experience for everyone who participated, but especially so for one of our firm’s Principals, Judy Cheng.

Last year, Cheng was the only rider from Segal to take part in the event. This year she had 17 teammates following her. Or racing ahead, depending on how fit and competitive they were feeling.

While it was a fun experience riding on Toronto’s busiest highways without any traffic, team SG Peloton’s goal was to raise funds to support programs at Baycrest for prevention, early detection, new clinical trials and improving care for people living with Alzheimer’s and other dementias. For Cheng the event was an unqualified success: “It was great to see so many of our team members riding to support Baycrest and its work for a future where every older adult can enjoy a life of purpose, inspiration and fulfilment.”

It was a real team effort. Thank you to everyone who rode in the race, and all the family and friends who came out to support us and help raise funds for Baycrest and its ongoing fight against dementia.

Committed to a better tomorrow

For more information:

Lavanya Sarathchandran
Marketing and Communications Manager
416.798.6929

LSarathchandran@segalgcse.com

The cross-border family trust

A trust is a popular tool used by taxpayers to sprinkle wealth among family members. Although in recent years the scope of the tool has been restricted, particularly in terms of the ability to income split, it is still valuable for a number of purposes, which may not be related to tax.

A simple family trust is a relationship created by a settlor, managed by a trustee who is holding property for the benefit of one or more beneficiaries, all of whom are residents of the same country. A simple family trust established by parents for family members may become a complicated family trust if the settlor, the trustee or the beneficiaries have a change of residency. These circumstances include:

  • For a Canadian trust, one or more of the beneficiaries became non‑residents
  • For a Canadian trust, due to a change of residency for the trustee(s), it is managed by a majority of non‑residents
  • A non‑resident trust with Canadian beneficiaries

Residence of a trust

The tax department considers a trust to be resident where its mind and management rests. This generally is where the decisions of the trust are made. Often, it is where the majority of the trustees reside. If resident and non‑resident trustees co‑exist, the residence of the trust will align with the person who has most or all of the powers or responsibilities, including those related to banking, financing arrangements, trust assets and reporting to the beneficiaries.

A Canadian resident trust may flow through Canadian source dividends and capital gains to its Canadian beneficiaries. It may also decide to split the tax burden between the trust and the Canadian resident beneficiaries, depending on their circumstances. However, these sources of income lose their tax beneficial treatment if paid to non‑resident beneficiaries.

If a trust ceases to be a Canadian, the trust will be deemed to have disposed of all its assets at the departure date and may realize a capital gain. If there is a tax treaty between Canada and the new country of residence, the deemed proceeds taxed in Canada may be recognized as the assets’ cost in the foreign country.

If a trust becomes a non-resident, it will likely be required to file a tax return in another country. A non‑resident trust will also be required to file a Canadian return under certain circumstances. The trust will need to ensure the double payment of tax is minimized.

Part XIII tax on distribution of income

Where any part of the income of a trust is payable to a non-resident beneficiary, the amount is subject to Part XIII withholding tax on the earlier of the day the amount was paid or credited and 90 days after the end of the trust’s taxation year. This means the tax is payable at the same time as the trust’s tax return.

Any amount paid or credited by a trust to a beneficiary is deemed to have been paid as income of the trust, regardless of the source from which the trust derived it. Even if the amount was received by the trust in a form which, if it had been paid directly to the non‑resident beneficiary, would have been exempt from withholding tax, Part XIII tax will still apply when it is paid by the trust to the non‑resident.

If the trust received capital dividends and distributed the amount to its non‑resident beneficiary, the capital dividend is subject to Part XIII tax. Such dividends would not be subject to tax if paid to the resident beneficiary.

Interest that would ordinarily be exempt from withholding tax if paid directly to the non‑resident beneficiary is subject to withholding tax if received by a trust and distributed to a non‑resident beneficiary.

Taxable capital gains of a trust that are payable to a non-resident beneficiary are subject to Part XIII tax. Even though a payment of such gains is a “payment of capital” under trust law, the CRA considers the distribution of the taxable portion to be a distribution of trust income and not capital. Therefore, it is subject to withholding tax. The non‑taxable portion of the trust’s capital gains does qualify for exemption as payment of capital.

Deemed resident trust

The deemed resident trust rules require careful analysis of all the facts and circumstances surrounding a trust.

Mr. A currently lives in the U.S., and he plans to become a resident of Canada. Before becoming resident in Canada, he made a contribution to a U.S. trust. At the time he becomes a resident of Canada, the U.S. trust will have a resident contributor and will be a deemed resident trust from the beginning of the year (not just from the time Mr. A becomes a Canadian resident).

A resident beneficiary is a Canadian resident who is a beneficiary under the trust, and there is a “connected contributor” to the trust at that time. A connected contributor is someone who has made a contribution while resident in Canada or within 60 months of moving to or leaving Canada.

Mr. B moved to the U.S. and established a U.S. trust within 60 months of leaving. The U.S. trust is for the benefit of his Canadian resident children. The trust will be deemed Canadian resident from the beginning of the year in which Mr. B made a contribution to the U.S. trust.

In addition to the above, there are many situations that may require a change in how one views the tax consequences of a trust. It is important to consult your tax advisor whenever contemplating a move to or from Canada.

Insight that follows you everywhere

Liquidity Alternatives

Liquidity Options for Privately Held Businesses

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In my previous article, Preparing for a liquidity event, I discussed how to prepare a business for a liquidity event. Proper preparation ensures a business is well‑positioned when unexpected events result in a need for liquidity.

What is a liquidity event?

A liquidity event is a transaction through which corporations and/or their controlling shareholders gain financial liquidity as a result of a sale or recapitalization of a business.

In order to ensure optimal outcomes for all shareholders and allow them to best meet their objectives it is recommended business owners consider a number of different types of liquidity alternatives.

Shareholder motivations for liquidity

The desire for a liquidity event may be motivated by one or more of the following personal and business circumstances:

  • Business owners may wish to “take some money off the table” and reduce personal financial risk by diversifying their assets.
  • Business owners may look to take a step back from the business to pursue other interests or retire.
  • Unexpected personal circumstances, such as a death, deteriorating health or divorce, may require the division of family assets.
  • A shareholder may elect to leave the business due to a challenging interpersonal situation resulting from mutual ownership with other individuals with different personalities.
  • Owners may encounter increased competition and margin compression, challenging future growth and possibly throwing into question the future viability of the business.

Liquidity alternatives

A liquidity event can take many forms,including:

  • Management/employee‑led buyouts: selling a company to its existing management or employees.
  • Recapitalizations and financial restructurings: infusing new capital into a company to facilitate growth and the partial buyout of existing shareholders.
  • Divestitures: selling a company to a strategic or financial investor that is external to the business.
  • Raising private capital: raising debt and/or equity capital to facilitate growth or ease liquidity constraints.

Characteristics of liquidity alternatives

Each of the transaction alternatives noted above has certain characteristics that make it a better option for addressing shareholder motivations and realizing shareholder objectives under a set of circumstances. Some of these characteristics include:

  • Confidentiality: increased ability to maintain a higher degree of confidentiality about the transaction process and the fact that existing shareholders are looking for a buyer or investor.
  • Speed: ability to be executed more rapidly due to the familiarity of the buyer/investor with the business and/or the fact that the required capital for the transaction is readily available.
  • Growth & upside: certain of the alternatives allow existing shareholders to continue to retain an interest in the company where they believe considerable future growth and upside potential exists. These alternatives involve partnering with seasoned investors with access to tangible resources, experience and knowledge not available to the existing management and shareholders.
  • Price: by their nature, some of the alternatives will be directed to a broader pool of potential buyers/investors and a more formal auction process will likely be undertaken. Broad auction processes that target strategic investors are typically considered optimal from the perspective of price maximization.
  • Use of proceeds: by design, certain of the alternatives will result in existing ownership being diluted, taking chips off the table and diversifying their personal assets. Other alternatives do not necessarily (immediately) allow for these options.
  • Ongoing ownership and management: certain of the alternatives result in existing ownership severing the relationship with the company immediately while others result in continued ownership and potentially holding management roles going forward. One needs to contemplate the various alternatives taking into consideration the shareholders’ comfort level with having additional/new stakeholders at the table.

Conclusion

We often find that shareholders desiring a liquidity event are fixated on a particular form of transaction. Given the range of transaction alternatives available, it behooves business owners to carefully consider all options so they can identify the type of transaction that allows them to best meet their personal and business objectives.

Informed decisions, optimized value

For more information:

Nathan Treitel
Managing Director – Valuation and Transaction Advisory
416.798.6916

NTreitel@segaladvisory.com