Three Tax Trends Everyone Needs to Know About Executive Compensation in 2023

On the executive compensation front, 2023 looks to be an interesting year for employers given higher salaries, inflation and low unemployment. Combined with a somewhat depressed market and a reset of many companies’ share prices, now may be a good time to grant employees compensation tied to share value. In this vein, below are three key tax trends currently shaping executive compensation in Canada.

1. Stock Options

Current market conditions are causing companies to consider granting stock options as compensation. Specifically, if the value of a share has decreased from its highs during the pandemic, now may be a suitable time to grant stock options, so that any increase in future value is captured by such options. A stock option plan can usually be structured to provide for a 50% deduction on the employment benefit that is triggered on exercise (or disposition of the underlying share if the company is a Canadian-controlled private corporation (“CCPC”)). However, the aftermath of recent tax rules has affected the way certain non-CCPCs or public companies grant stock options because of the cap on the 50% deduction to $200,000 (for more information, see our previous update here).

2. Taxation of International Executives

The pandemic accelerated the ability of employees to work from home or abroad and has allowed Canadian companies to find talent all over the world. As more Canadian companies operate globally, they have had to consider compensation issues relating to cross-border assignments, foreign tax credits, the employment tax rules of other countries and permanent establishment considerations. Canadian employees also need to consider foreign tax considerations when working abroad. Of specific note is a recent Canada Revenue Agency (“CRA”) interpretation that comments on the method to apportion benefits underlying restricted share units (“RSUs”) between different countries to determine the quantum of taxes to be paid in each country. When employment duties underlying an award of RSUs are performed both within and outside Canada, the resulting benefits arising from the settlement of the awards may be taxable both in Canada and the other country. The CRA has issued a complicated methodology to source RSU benefits between Canada and the other country which some companies may find difficult to manage.

3. Tax-Efficient Structuring of M&A

2022 was a busy year for merger and acquisition (“M&A”) transactions involving Canadian companies. It is expected that 2023 will be no different. Tax efficient payments to employees are always an important consideration, especially because key employees may be of strategic importance to a purchaser. Structuring transaction bonuses or cash-outs of options involve nuances that, if not carefully considered, can lead to higher taxation. Given the uncertainty of the market, one specific trend that arose in 2022 and is expected to continue in 2023, is the inclusion of earn-outs in M&A transactions. Earn-outs allow a portion of the purchase price paid to acquire a company to be determined at a later date based on the value of the underlying goodwill of the company. For option holders who exercise their options immediately prior to a transaction, the amount of tax owed is determined based on the fair market value of the shares on the date of exercise. When an earn-out is involved, the present value of such earn-out must be included in the value of the shares which can be difficult to determine.

If you have any questions with respect to the matters discussed above, please contact Katy Pitch by email at [email protected].

This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.

If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.