Repricing and backdating

In Canada, not only is there no super-inclusion or penalty tax regardless of the option’s exercise price relative to the value of the shares on the option grant date, but also provided that the options are at-the-money (or backdated to appear as such), only one-half of the option benefit is included in income for tax purposes regardless of the length of time that the shares are held after exercise.[61] This demonstrates a clear tax advantage for stock option compensation, provided that the options are granted not-in-the-money (or reported as such). § 409A should have reduced the incidence of backdating in the United States. An executive at a publicly traded company is the recipient of an option grant for 30,000 shares which expires ten years after the date of the grant. § 409A.[67] For the purposes of demonstrating the impact, if any, of minimum tax in Canada and AMT in the United States, it is assumed that the executive has gross taxable income not derived from any issuance, exercise or sale of stock options or the underlying stock, of 0,000 and does not benefit from any tax preference other than the preference (if any) associated with employee stock options. For a Canadian executive, if the option is “successfully” reported as an at-the-money grant awarded on October 16 with a strike price of .25, then the income benefit subject to tax is calculated as the difference between the fair market value of the shares on the date of exercise and the strike price multiplied by the number of options awarded, which is 5,600.

In Canada, employees who receive backdated stock options, the equivalent of in-the-money options (assuming that the fair market value of the shares on the real grant date exceeds the strike price under the option), may be reassessed by the Canada Revenue Agency not only to deny any deduction claimed under paragraph 110(1)(d), but also to include the employee benefit from the option in income in an earlier year than that in which the employee reported the benefit (and offsetting deduction) for tax purposes. In addition, ISOs that are backdated do not meet the necessary requirements for preferential tax treatment (assuming that the shares are held for at least a year after exercise) and instead must be treated as backdated NSOs for tax purposes. § 409A) in addition to the year the shares are ultimately sold. § 409A, such executives could be subject to gross negligence penalties and perhaps charged with tax evasion.[64] Based on the standard model of tax evasion by Allingham and Sandmo,[65] where compliance is positively associated with the size of penalty assessed if caught, one might expect that the punitive consequences of I. However, there continues to be some evidence of backdating in the United States,[66] suggesting that executives may perceive there to be a low risk that the IRS will apply I. This award is dated as having been granted on October 16 when the share price was .25, but in reality was granted on November 30 when the share price was .40. executive, that such options expire or are all exercised prior to the introduction and application of I. Based on this assumption, minimum tax will not apply in any of the examples and AMT will apply only in the fourth example. The individual claims a deduction under paragraph 110(1)(d), which reduces the income inclusion to 7,800.

Another piece is the insider reporting obligations imposed upon some executives by securities regulations.[14] Given a lenient disclosure regime for reporting the grant and exercise of stock options,[15] as some have argued currently exists in Canada,[16] backdating could easily go undetected.

Greed is often cited as the motive for backdated options.[17] However, while greed could account for a desire for higher compensation, it cannot account for the form that such compensation takes. The exemption amount begins to be phased out when AMTI exceeds a threshold (0,000 for a married individual filing a joint return; 2,500 for a single individual). The deferral of the income inclusion for an ISO is an adjustment in computing AMTI, resulting in the addition to regular taxable income in the tax year in which the option is exercised of an amount equal to the difference between the fair market value of the shares and the exercise price of the option.

If an employee exercises options that are otherwise qualified as ISOs but then disposes of the shares within one year of exercise or within two years of when the options were granted, the employee stock option benefit (as determined above for a NSO) is not included in income until the time of sale of the shares and the difference between the sale proceeds and the fair market value of the shares at the time of exercise is taxed as a short-term capital gain.[44] Short-term capital gains are taxed at the individual’s ordinary income tax rate.[45] However, if the shares decline in value between the time of exercise and the time of sale, then the employee benefit is limited to the difference between the sale proceeds and the strike price under the option.[46] Prior to the introduction of § 409A to the Code in late 2004, if the fair market value of an NSO was not readily ascertainable at the time of grant, no income was recognized for tax purposes until the option was exercised, regardless of whether or not the options were in-the-money on the grant date.[47] In either case, upon exercise, the amount included in income (and subject to tax at normal tax rates as compensation income) was equal to the difference between the strike price and the fair market value of the stock on the date of exercise.[48] This amount was also added to the basis of the stock for capital gains purposes.[49] Any further taxation was deferred until the underlying shares were sold, when the gain or loss—i.e., the difference between the sale price and the fair market value on the exercise date—was taxed as a capital gain or loss.[50] If the shares were held for one year or less, the gain was taxed as a short-term capital gain (taxable at regular marginal rates) whereas if the shares were held for more than a year, the applicable rate was the long-term capital gains rate, which is currently fifteen percent.[51] This tax treatment remains applicable to options provided that they are not in-the-money at the grant date. § 409A provides in part: (a) Rules relating to constructive receipt (1) Plan failures (A) Gross income inclusion (i) In general.—If at any time during a taxable year a nonqualified deferred compensation plan— (I) fails to meet the requirements of paragraphs (2), (3), and (4), or (II) is not operated in accordance with such requirements, all compensation deferred under the plan for the taxable year and all preceding taxable years shall be includible in gross income for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income. S.[21] It is important to understand the differences in these rules, particularly the extent to which these differences affect the after-tax return to a Canadian executive compared to a U. Part II considers these personal income tax rules in detail. For individuals, the exemption amount depends on whether the individual is married and filing a joint return (in which case the amount is ,000) or is a surviving spouse (,000) or is single (,750). In particular, the relevant personal income tax rules in the two countries are compared and contrasted to demonstrate the role these rules may play in determining the demand for backdated options in the two countries.[23] As will be shown, this is potentially an important component in the decision of executives to accept backdated stock options and may provide an additional incentive for executives to demand them in Canada. Following corporate and accounting scandals such as Enron, Tyco, and World Com, the American Jobs Creation Act of 2004 added § 409A to the Code,[52] which radically changed the taxation of deferred compensation, including discounted stock options.[53] I. (ii) Application only to affected participants.—Clause (i) shall only apply with respect to all compensation deferred under the plan for participants with respect to whom the failure relates. § 409A applies to a broad range of deferred compensation, although it also provides a number of exceptions, including employee stock options that are granted not-in-the-money.[54] However, in-the-money options (including backdated options that appear to be not-in-the-money options) are caught by the section. (B) Interest and additional tax payable with respect to previously deferred compensation (i) In general.—If compensation is required to be included in gross income under subparagraph (A) for a taxable year, the tax imposed by this chapter for the taxable year shall be increased by the sum of— (I) the amount of interest determined under clause (ii), and (II) an amount equal to 20 percent of the compensation which is required to be included in gross income. Under § 409A(a)(1)(A), the “compensation deferred under the plan” must be included in the employee’s gross income “for the taxable year to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.”[55] In addition to the income inclusion, § 409A(a)(1)(B) provides that the tax payable on such income is increased by “premium interest tax”[56] plus an “additional tax” (commonly referred to as a penalty tax) equal to twenty percent of the compensation required to be included in gross income.[57] Generally speaking, a taxpayer must include in income an amount attributable to a grant of in-the-money stock options in the year that the options vest and in every subsequent year up to and including the year of exercise (to the extent not included in income in a previous year).

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The applicable tax rules for stock options granted by publicly-traded companies are set out in section 7 and paragraph 110(1)(d) of the Canadian Income Tax Act.[25] Section 7 pertains to the value and timing of the employment income inclusion and paragraph 110(1)(d) provides a deduction equal to one-half (reduced to one-fifth for the purposes of computing minimum tax[26]) of the income inclusion if certain conditions set out therein are met.

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