Budget affects stock options, TFSAs and Individual Pension Plans

By Darren Coleman

This article was originally published by The Lawyer’s Daily, part of LexisNexis Canada Inc.

Finance Minister Bill Morneau has tabled the Liberal government’s federal budget. He forecasts another year of deficits — $15 billion for the current year, $20 billion for next year, and no forecast for a return to a balanced budget any time soon. This is a far cry from the government’s pre-election promise of balancing the budget by 2019 as they will have added $75 billion to the national debt under their current mandate.

While the budget offers no changes to personal or corporate income tax rates, the proposed changes will directly impact some taxpayers. Let’s have a look.

For starters, the budget removes preferential tax treatment on stock options for certain employees. Currently, stock options are treated at the same beneficial rate as capital gains, for which only 50 per cent of the gain is taxable. But now the budget limits the preferred tax treatment for employees of “large, long-established, mature firms” by capping the value of this benefit at $200,000 per year, based on the market value of the underlying shares.

This means that any stock options granted above this limit will be 100 per cent taxable as regular income. Employees of startups and Canadian growth companies will not be subject to this cap.

The budget, which did not provide further details to define these terms, or an implementation date, said any new measures would be applied on a prospective basis and would not apply to stock options granted before any legislative proposal date. While much here is still to be determined, there is no need for a taxpayer to accelerate the exercise of existing stock options grants in order to continue to benefit from the 50 per cent deduction.
However, if the current, or even future governments, enact this measure, it will be interesting to see how large corporations create pay packages to attract and keep top employees, especially since marginal tax rates for U.S. residents continue to decline. Bottom line — the wage gap between Canada and the U.S. keeps widening, which means it will be harder to attract and keep valuable employees in this country.

Next point. If the Canada Revenue Agency believes that the holder of a Tax Free Savings Account (TFSA) is carrying on a business on the day of trading in the account, the TFSA holder is now liable for tax owing on income earned in that account. Under current legislation, with the same scenario, the TFSA itself and the financial institution that issued it are “joint and severally” liable for the tax owing. But not the account holder.

It’s reasonable that the TFSA holder carries the risk, and not the financial institution, but the budget doesn’t provide any clarity about what “carrying on a business” actually means.

This is something the Investment Industry Association of Canada and tax practitioners have been asking for.

The third point is that the budget has also terminated an aggressive tax-planning option which some employees have used in order to avoid tax on the commuted value of their defined-benefits pension plans. What does this mean?

When someone is no longer a member of a defined-benefit pension plan, the value of the plan can be significant, especially if the person has decades of service. The full value can be transferred to another pension plan offered by a new employer. If the person moves the plan to an RRSP, only about 50 per cent of the value can be moved tax-free and the remaining amount is fully taxable as regular income.

Aggressive techniques — some may call it “abuse” — to counter this include incorporating your own business and establishing an Individual Pension Plan to transfer 100 per cent of the assets into the new account. This offsets the restrictive transfer to the RRSP.
There have been several cases over the last decade concerning this “abuse” of the transfer limits to the IPP from a defined benefit pension plan. See: Nelson v. Lavoie 2018 ONSC 4489; 1346687 Ontario Inc. v. Canada (Minister of National Revenue - M.N.R.) [2007] FCA 262; and Jordan Financial Limited on Behalf of The Pension Plan For Presidents Of Jordan Financial Limited v. MNR [2007] FCA 263. The new budget now quashes such planning.

In conclusion, proposed changes with this budget — and remember, many of the budget proposals need royal assent before being passed into law — are nominal and are targeted to specific taxpayers. But another thing to remember is that this is an election year, so who knows which items move forward? One thing is for sure though; it is always prudent to seek expert financial and legal advice before you do anything rash.

Darren Coleman is a senior vice-president and a financial advisor with Raymond James in Toronto. He is the author of RECALCULATING: Find Financial Success and Never Feel Lost Again.
Photo credit / daoleduc ISTOCKPHOTO.COM
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