Certain key measures that were introduced in the March 2010 federal budget are not yet in force. To address issues raised by the changes for charities and stock options, the Department of Finance released a consultation draft in August. Meanwhile, however, many tax planners have been giving advice as if the measures are already in force.

There are two main proposed changes concerning stock options. The first is that when employees exercise stock options, they would have to pay the taxes owing in the current taxation year; previously, they could defer the taxes until the stock was sold.

This tax would be levied on 50% of the taxable employment benefit — the difference between the price the employee pays and the stock’s current market price — and be considered employment income. Employers would be required to withhold the taxes owing if feasible. In some cases, it wouldn’t be.

For example, if the taxable employment benefit is $200,000, the employee would have to come up with about $50,000. A loan would be one route to go, but it would have to be paid back; thus, many employees may prefer to sell a quarter of the shares — especially if they have other debts, such as a mortgage.

Indeed, there is anecdotal evidence that many employees who are exercising stock options are selling shares to raise the cash needed, says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto.

This isn’t a major problem if the stock is that of a large company, which has many shares that are widely held and actively traded. However, it could be a problem if the stock belongs to a small company with relatively few shares that are thinly traded.

For such small firms, the idea is to encourage employee ownership and to have much of the stock in the hands of employees. The need for employees to sell some of their shares is counterproductive to the achievement of this goal.@page_break@Furthermore, with a thinly traded stock, the price received for the shares may be below the market value when the employee exercises the shares, which is to the employee’s disadvantage.

The second change concerning stock options would be the closing of a tax loophole whereby if employees choose to take cash rather than exercise options — which is allowed in some stock-option plans — the company previously could deduct that payment while employees would pay taxes on only 50% of the cash received.

Ottawa is proposing to disallow the company deduction in such cases. This will mean companies are unlikely to continue to offer the cash option. Thus, employees will have to take the shares and then sell them if they want the cash.

There is, however, one positive change for those employees who currently have a deferred tax liability as a result of exercising stock options: if the share price is much lower when the employee-shareholders sell than at the time of exercising their options, they could elect to pay only what they receive when selling the shares if that is less than the deferred tax liability.

On the charity front, the changes in the 2010 budget are important for financial advisors who have charities as clients to note. These changes are effective for taxation years ending on or after March 4, 2010 — and the Canada Revenue Agency is administering them as if they were law, says Kate Lazier, partner with Miller Thomson LLP in Toronto.

The biggest change is the elimination of the disbursement rule. That provision had required that 80% of donations received by a charity be spent on charitable work.

However, this rule was sometimes onerous for rural and small charities, as donations are usually the source of most or all of their revenue. Larger charities didn’t have trouble meeting the rule.

The elimination of the disbursement rule doesn’t mean charities can spend as they like. The accumulated capital rule still applies, which requires that 3.5% of accumulated capital be spent on charitable activities each year. However, charities are still allowed to have capital earmarked for particular projects excluded from the calculation if they have prior written permission from the CRA.

With the elimination of the disbursement rule, the CRA’s fundraising guidelines, effective as of June 11, 2009, have become more important. The Department of Finance will monitor the effectiveness of these guidelines to ensure that their objectives are met. Lazier recommends that advisors involved with charities review these guidelines.

IE