Tale of two tax stories by the CBC; One total BS and one not BS, but I have quibbles

Harper government partnered with industry group fighting CRA over KPMG case

This is a non-story and the insinuation of the headline is false and biased. It implies that the PM was complicit in tax evasion, which is just untrue. I hate the Tories, but I hate crappy tax reporting more. So the real story here is that the Accountant’s lobby group interacts with the government all day long every day because the accountants effectively enforce the tax code on the population/corporations because they calculate profit/income and file tax returns. Accountants’ input is critical to an efficient tax system. The government interacts back all day every day, and has done so forever under all parties/governments. The accountants’ lobby group has been pushing for privilege in their tax advice and documents for years (meaning they would not have to turn them over to the CRA on demand). The Supreme Court of Canada has always said no, for one very good reason. Accountants are not lawyers and bound by the same rules of professional responsibility. And they are not lawyers, and the Supreme Court are all lawyers and they know all their lawyer friends would disown them if they gave privilege to accountants. So no privilege. KMPG basically got caught advising people to continue using a structure after it became obvious that it was no longer viable, if it every was. KPMG were pushing really hard to keep their client list out of the hands of the CRA because recent rule changes can put them on the hook for “advisor liability”. The Accountant’s lobby doubled down and re-iterated their long-standing but hopeless claim for privilege. None of this is scandalous. At all. Moving along… Well except for KPMG’s advice to their clients, that is scandalous … And the way this story is spun as being anti-Tory. This is clearly biased journalism by the CBC, because they know another Conservative government will gut them….

Anyway, the second story by the CBC is actually not bad, but I have quibbles.

Canada election 2015 spin cycle stock options

The NDP and the Liberals are proposing that stock options be fully taxed. Or not, they have wobbled since they got complaints about it, but still, my complaints goes well beyond what is in the story. Before I get into it, I find it fascinating that most of the time people have opinions about tax issues without knowing any understanding about how the system works, which is also partly why the NDP and Liberals came up with this bonehead policy. For those of you who do not know, a stock option under the income Tax Act is the right to purchase a share of a corporation that you work for (or the employer’s parent company). The purchase price is the current fair market value of the share as of the date of the issuance of the option. In order to qualify for advantageous tax treatment you can only have a purchase price of a flat CAD$100k. But you usually do not have the right to exercise the option to purchase shares for a number of years, and the hope is that the share price rises in the interim. The objective of stock options is not to compensate CEOs of large corporations, as the NDP and the Liberals seem to be implying. Think about it. If the share price of the company is $20, then you can only be given 5,000 qualifying options ($20 X 5000 = $100k in purchase price.) If the price doubles in three years, the amount of income is $100k ($40 new price, less $20 price paid times 5000 units = $100k). No CEO of a major corporation cares about a measly $100k, OK? So the point of stock options in Canada is to allow small growing tech and start-up corporations to hire and keep top people for less cash up front, in anticipation of a big (lower tax) payday later. So stock options are a critical component of the innovation economy. Increasing the tax on stock options makes “investing” your time and efforts in a start-up less worth-while. So fewer people will do it. As per my previous blawgs, if you tax something more, you are discouraging it. So despite all of the Liberal/NDP rhetoric about building a brighter high-tech future, they just do not get it. The point of stock options is to make people fabulously wealthy if they invest in start ups, so rather than complain about “rich people” benefiting, they should be celebrating that these people who have taken a big risk, worked hard and grabbed the brass ring. Not that the Tories are any better, but this policy of taxing options is just stupid.

However, the CBC article points out, without really nailing it down, is that the NDP position that getting rid of this “loophole” will raise $2 billion over 4 years to fight child poverty. OK, nice ideal, but 1) stock options are not a loophole, they are a deliberate and beneficial tax policy choice to encourage start-ups and innovation; 2) the change will actually cost the government money…. If they change the taxation of stock options, corporations will just change the format of their compensation for executives/employees. They will just get rid of stock options and give bonuses. Bonuses are deductible to the corporations, stock options are not. Which the CBC article pointed out, but they did not go all-out to drive a stake through the NDP position. So lets just do some math. Stock options are treated like capital gains= half of the “spread” between the cost of the option and the exercise date value of the share is taxable. So if you were issued 5k options for $20 each a couple years ago, and the company share price is now say $40 then the spread is $20, and the taxable amount is $10 per share. In Ontario (the math works the same in any other province) then the top tax rate is 48%, so effectively you pay $24 in tax on every $100 in stock option income. This is not bad. But if the company changes its system and just agrees that you will receive a $100k bonus if the share price hits $40, then you would receive $100k, and be taxed at 48% so you pay $48 in tax on every $100 income. Ok so far, but the corporation gets to deduct the $100k from its profits, resulting in a corporate tax deduction of $26 per $100 in Ontario. $48 minus $26 is $22 in total government income. So getting rid of the stock option results in lower taxes generated ($24 vs $22 per $100 in income) …. so there will be no money for child poverty reduction, sorry Tom. Justin’s position that he would limit the benefit to the first $100k in “spread” is almost as dumb, because it only has a marginally less negative impact on the innovation economy.

Jack Mintz (a famous Calgary tax policy guy) says he is OK with getting rid of the benefical stock option tax treatment because effectively Canada is the only country that allows stock options but does not allow the corporation to deduct the cost of options, and we should just do like the US and fully tax options but allow a deduction to the corporation. With all due respect, this position is also nuts. Stock options are effectively a dilution of the shareholders, and a balance sheet operation, not an income statement transaction, so there is no logical basis for a deduction from income. Why should a company get an income deduction for diluting the existing shareholders? If the company had to buy the shares back on the market at the current price and sell them to the employees at the lower old price, I can see the company taking a capital loss, but a deduction? That is just a recipe for companies to trash their current shareholders … which is what happens in the US all day long. So frankly, the Canadian system, as it is right now, is better than the US system. It treats stock options as what they are, compensation for employees who could go elsewhere and work for more money, but instead decide to invest in the start up company with their sweat and brain-power.

What really ticks me off is that the CBC, NDP and Liberals seem to think that they can just spout tax nonsense and expect that people will not call BS on them. Again, I hate the Tories and I hope they lose on the 19th, but please would somebody in the other two parties actually ask someone who has some clue (and not just me!) about tax policy before they spout garbage? Is that too much to ask?

Jonathan N. Garbutt, Barrister & Solicitor

The opinions expressed herein are my own, and are not intended as, and should not be construed as tax or legal advice.

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